Toward an early warning system of financial crises: What can index futures and options tell us?

•Paper develops an EWS of financial crises.•Models significantly improve the medium-term predictability of equity market crises.•Variables that provide information of a crisis: the VIX, open interest, volume, put option price and effective spread, and Treasury term spread.

This research develops an early warning system (EWS) for equity market crises based on multinomial logit models and variables relating to the information content of index futures and option markets. We show that the information impounded in S&P 500 futures and options is useful as leading indicators of financial crises. Results reveal that models estimated with futures and put options significantly improve the medium-term predictability of equity market crises. Variables that consistently provided information of an impending crisis include: the VIX, open interest, dollar volume, put option price, put option effective spread, and the Treasury term spread.