Could you give an example of how you are modeling the 25riskreversal. I mean detailed simplyfied stock example with all the numbers, and how you then make use of it.
Sure thing. Lets imagine that you are looking at SPYs, so here is your option chain for November regular expiration (this is ref 167.62 spot): Code: %Strike Strike CDelta PDelta IVol 94.3% 158 0.81 -0.19 20.06 94.9% 159 0.79 -0.21 19.63 95.5% 160 0.77 -0.24 19.24 96.1% 161 0.74 -0.26 18.79 96.7% 162 0.71 -0.29 18.24 97.3% 163 0.68 -0.32 17.85 97.9% 164 0.65 -0.35 17.39 98.4% 165 0.61 -0.39 16.88 99.0% 166 0.57 -0.43 16.4 99.6% 167 0.53 -0.47 15.84 100.2% 168 0.49 -0.51 15.33 100.8% 169 0.44 -0.56 14.85 101.4% 170 0.39 -0.61 14.34 102.0% 171 0.34 -0.66 13.87 102.6% 172 0.29 -0.71 13.48 103.2% 173 0.24 -0.75 13.07 103.8% 174 0.2 -0.8 12.69 104.4% 175 0.16 -0.84 12.4 105.0% 176 0.12 -0.87 12.16 So, to get your 25-delta risk reversal, you find an call with delta closest to 25 (in this case 173 strike) and put with delta closest to -25 (in this case, you are better off averaging vols from 160 and 161 strike puts). So, your 25-delta risk reversal is -5.95 vols (general convention is to quote calls over puts). Given that your ATMF strike is around 167.5, the vol for it would be about the average of 167 and 168 strikes (15.6) and your normalized risk reversal would be -.38. SK10 can be calculated two ways and it will produce different numbers, but as long as you are consistent, it will not matter much. One way (the one I like), is to take ATM spot strike vol and vol for 100%-10%*sqrt(t), which in this case is 96.6%. This would give you about -2.8% sk10. Alternatively, you can take the actual 90% strike and adjust the difference by the square root of time, in this case (strike not included) it would give you about -2.6% because it includes some curtosis on the far wing. Does this help?
yes that was great explanation, thank you. .... sorry but i didn't got that from the beginning,what is sk10 and 'normalized' risk reversal.