Behavior of Index and Stock curves

Discussion in 'Options' started by VolSkewTrader, Jan 26, 2019.

  1. I haven't traded stock indexes (SPX, NASDAQ-100, RUT, etc) or stock options in awhile. Can someone give me a quick refresher on how their implied vol curve and shapes (in general) behave? Is the curve or put skew (relative to the calls) likely to steepen (higher slope values between strikes) on a break vs a rally? Do vol curve skews flatten out in general for stocks on rallies? If the latter is the case, why does the CBOE SKEW indicator have such high readings when the stock market is on its highs and vol on its lows, and low readings when the VIX is 25+ and the market is in a panic sell-off?

    I also noticed that a few implied volatility skew indicators for the SPY had the puts exploding vs the calls during the last year's (late 2018) stock market meltdown, but yet at the same time the CBOE SKEW indicator was printing low values during this correction. I'm guessing that the SKEW indicator was no longer pricing in a fat tail event because it was already currently taking place in the markets, but that would imply that the put skew would also have flattened out if the downside fear was removed by the marketplace, which by all indications it did not, but rather steepened significantly vs the calls (higher strikes).

    And how often do you see the OTM call implied vols trading higher than the OTM puts for individual stocks? I can see this happening for takeover candidates, but which stocks in general have upside fear trumping the downside fear? Tech, Biotech, small cap? Or is this a rare occurrence and only seen during a low vol bull market environment.
  2. IMHO: For SPX; calm market or trending up market results in lower Implied Volatility with increased SKEW! A large volatility event (big move down, or Backwardation), will result in lower SKEW, but higher Implied Volatility. Take a peak of the volatility surface during normal times VS during a big VIX event to help get your bearings.
  3. Thanks for responding. So prior to a stock market correction, in a low vol environment (VIX between 10 and 12) would you be better off purchasing an OTM call trading at 8% delta-neutral (fully hedging the delta to lock in the extrinsic value) or purchasing a much steeper same delta OTM put trading at 16% and delta-neutral hedging it the same way).

    Which one would would have made more money during last year's stock market correction, given that both option IV's exploded? I'm going to guess that the puts increased less in IV terms than the calls (skew flattened), but the exploding vega of the puts won out since the underlying (S&P 500 futures, SPY, e-minis) blew through the put strike and the calls became far out wings with little vega. So despite the OTM puts trading at a substantial premium to the OTM calls in a low vol environment, they're probably much better to own when trading delta-neutral during a meltdown in the market.

    I'm also going to guess that the OTM puts are better to own when trading delta neutral than the same delta OTM calls on a vol-crushing rally, since the vol skew steepens in favor of the puts like you said. Is it ever better to own the calls vs the puts in the SPX, SPY, or any index or stock? A slow grinding market decline accompanied with lower implied vols probably has never happened.
  4. Robert Morse

    Robert Morse Sponsor

    Skew shape tends to tilt up and down a little based on market conditions, but it would be rare to flatten or reverse when it comes to indexes that represent baskets. In general, stock index 25 delta puts will always be materially higher than the 25 delta call. The VIX OTM put will be materially lower than the OTM call. Sometimes to an extreme as the VIX can only go so low but has little limits on the upside.
  5. srinir


    CBOE has a SKEW index based on SPX options. Recently it went from highest in its history to one of lowest in very short period SKEW value of 100 represents flat skew.

    Last edited: Jan 27, 2019
  6. It's clear that the SKEW index is in general negatively correlated with the VIX index. It doesn't make sense that it is labeled a "fear" indicator when it measures at extremely high levels while the market is most complacent and not worried about a correction (when VIX is sub 15), and has low readings when the "sky is falling" (VIX is 25+). So most traders probably misinterpret it. The SKEW index is simply a measurement of how expensive OTM puts are trading vs the OTM calls at any given moment.

    The concept that it is a "tail risk" indicator does make sense though. If the VIX is trading 10 or below (close to it's lows) then the chance for "tail risk" event should be at it's highest, since it wouldn't take much of a correction for the index to move 2 or 3 standard deviations lower with implied volatility so low.
  7. sle


    SKEW is a really strange animal because they are using power function payoffs on two expirations and interpolating (the idea was that it would be something that can be actually replicated). Because of that, there are plenty of situation when the actual option skew (as expressed via sk10 or risky/atmf) would move differently from the index. My suggestion would be to ignore the skew index and use the actual vol surface.
  8. srinir


    I would agree with @sle. There is something strange going on with SKEW index.

    Minneapolis Fed measures Skew based on longer term option prices (6&12) months. They are giving totally different picture than SKEW index.

  9. srinir


    Compare this with same chart above for the similar period. Below are based on 30 day vs 6 months time period of the above. But SKEW pattern is totally off

  10. Interesting chart. You can find a shorter term (30day constant maturity) skew chart at Market Chameleon at the following link:

    Mousing over the chart shows numeric data going back one year, or just scrape the data from the page for analysis. Its 25D RiskReversal skew (more appropriate for FX where sticky delta is the norm) rather than SK10, but it's easy enough to convert the numbers to SK10 for a time-consistent estimate for equities market skew.
    #10     Jan 28, 2019
    srinir and Robert Morse like this.