840 Part VI: Measuring and Trading Volatility 
The causes of this effect stem from the stock market's penchant to crash occa­
sionally. Investors who want protection buy index puts; they don't sell index futures 
as much as they used to because of the failure of the portfolio insurance strategy dur­
ing the 1987 crash. In addition, margin requirements for selling naked index puts 
have increased, especially for market-makers, who are the main suppliers of naked 
puts. Consequently, demand for index puts is high and supply is low. Therefore, out­
of-the-money index puts are overly expensive. 
This does not entirely explain why index calls are so cheap. Part of the reason 
for that is that institutional traders can help finance the cost of those expensive index 
puts by selling some out-of-the-money index calls. Such sales would essentially be 
covered calls if the institution owned stocks, which it most certainly would. This strat­
egy is called a collar. 
This distortion in volatilities is not in accordance with the probability distribu­
tion of stock prices. These distorted implied volatilities define a different probability 
curve for stock movement. They seem to say that there is more chance of the market 
dropping than there is of it rising. This is not true; in fact, just the opposite is true. 
Refer to the reasons for using lognormal distribution to define stock price move­
ments. Consequently, there are opportunities to profit from volatility skewing, if one 
is able to hold the position until expiration. 
It was shown in previous examples that one would attempt to sell the options 
with higher implied volatilities and buy ones with lower implieds as a hedge. Hence, 
for OEX traders, three strategies seem relevant: 
1. Buy a bear put spread in OEX. 
Example: Buy 10 OEX June 560 puts 
Sell IO OEX June 540 puts 
2. Buy OEX puts and sell a larger number of out-of-the-money puts - a ratio write 
of put options. 
Example: Buy 10 OEX June 560 puts 
Sell 20 OEX June 550 puts 
3. Sell OEX calls and buy a larger number of out-of-the-money calls - a backspread 
of call options. 
Example: Buy 20 OEX June 590 calls 
Sell IO OEX June 580 calls 
In all three cases, one is selling the higher implied volatility and buying options 
with lower implied volatilities. The first strategy is a simple bear spread. While it will