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+Trading Skew
+There are some trading strategies for which market makers have a natural
+propensity that stems from their daily activity of maintaining their
+positions. While money managers who manage equity funds get to know
+the fundamentals of the stocks they trade very well, options market makers
+know the volatility of the option classes they trade. When they adjust their
+markets in reacting to order flow, it’s, mechanically, implied volatility that
+they are raising or lowering to change theoretical values. They watch this
+figure very carefully and trade its subtle changes.
+A characteristic of options that many market makers and some other
+active professional traders observe and trade is the volatility skew. Savvy
+traders watch the implied volatility of the strikes above the at-the-money
+(ATM)—referred to as calls , for simplicity—compared with the strikes
+below the ATM, referred to as puts . In most stocks, there typically exists a
+“normal” volatility skew inherent to options on that stock. When this skew
+gets out of line, there may be an opportunity.
+Say for a particular option class, the call that is 10 percent OTM typically
+trades about four volatility points lower than the put that is 10 percent
+OTM. For example, for a $50 stock, the 55 calls are trading at a 21 IV and
+the 45 puts are trading at a 25 volatility. If the 45 puts become bid higher,
+say, nine points above where the calls are offered—for instance, the puts are
+bid at 32 volatility bid while the calls are offered at 23 vol—a trader can
+speculate on the skew reverting back to its normal relationship by selling
+the puts, buying the calls, and hedging the delta by selling the right amount
+of stock.
+This position—long a call, short a put with a different strike, and short
+stock on a delta-neutral ratio—is called a risk reversal. The motive for risk
+reversals is to capture vega as the skew realigns itself. But there are many
+risk factors that require careful attention.
+First, as in other positions consisting of both long and short strikes, the
+gamma, theta, and vega of the position will vary from positive to negative
+depending on the price of the underlying. Risk-reversal traders must be