34 lines
1.8 KiB
Plaintext
34 lines
1.8 KiB
Plaintext
Chapter 39: Volatility Trading Techniques
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VOLATILITY SKEWING
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839
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After the stock market crashed in 1987, index options experienced what has since
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proven to be a permanent distortion: Out-of-the-money puts have remained more
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expensive than out-of-the-money calls. Furthermore, out-of-the-money puts are
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more expensive than at-the-money puts; out-of-the-money calls are cheaper than at
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the-money calls. This distorted effect is due to several factors, but it is so deep-seat
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ed that it has remained through all kinds of up and down markets since then. Other
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markets, particularly futures markets, have also experienced a long-lasting distortion
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between the implied volatilities at various strikes.
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The proper name given to this phenomenon is volatility skewing: the long-last
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ing effect whereby options at different striking prices trade with differing implied
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volatilities. It should be noted that the calls and puts at the same strike must trade
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for the same implied volatility; otherwise, conversion or reversal arbitrage would
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eliminate the difference. However, there is no true arbitrage between different strik
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ing prices. Hence, arbitrage cannot eliminate volatility skewing.
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Example: Volatility skewing exists in OEX index options. Assume the average volatil
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ity of OEX and its options is 16%. With volatility skewing present, the implied volatil
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ities at the various striking prices might look like this:
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OEX: 580
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Implied Volatility
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Strike of Both Puts and Calls
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550 22%
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560 19%
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570 17%
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580 16%
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590 15%
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600 14%
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610 13%
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In this form of volatility skewing, the out-of-the-money puts are the most
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expensive options; the out-of-the-money calls are the cheapest. This pattern of
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implied volatilities is called a reverse volatility skew or, alternatively, a negative
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volatility skew. |