Skew and Reverse Skew

Discussion in 'Options' started by livevol_ophir, Jan 6, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    SOLF is a $260 million solar company in China. Note that vol is up with stock up.

    The company averages 1,485 option contracts a day - in the first 90 minutes over 16,000 have traded. The calls have traded 10:1 to puts. Further, the Net Deltas and Net Premium are substantially positive - indicating purchases of options and net long positions.

    The most active trades: Jan 7.5, Jan 10, Feb 10 and Feb 12.5 calls. Note the Feb calls are opening.

    The Chart illustrates four things:
    (1) The price increase of late.
    (2) The implied vol increase of late - IV30™ (red line) vs HV30™ (blue line).
    (3) The high level of option volume (height of volume bar) and
    (4) The propensity of opening order customer call purchases

    Note this is a stock going up with vol also increasing. Volatility skew is the shape of the vol curve in a month going across strikes. Normally this is a downward smile (or smirk) - Lower strikes have higher vol than higher strikes. This is because the investing world (retail, mutual funds, pension funds) are generally long stock.

    (1) They buy puts for downside protection - raising the price (supply/demand) and therefore increasing the vol.
    (2) They sell upside calls for income on the long shares - lowering the price (supply/demand) and therefore decreasing vol.

    This relationship generally holds true. That's one reason (there are more) why when stocks go down, vol goes up. i.e. stocks go down, people long stock buy puts for protection -> greater demand for options -> higher vol.

    Similarly, that's why vol goes down when stocks move up. i.e. stock moves up -> longs stock sell OTM calls for income -> less demand for options -> lower vol.

    But, for certain types of companies, the demand for upside calls is so great that the skew (vol) heads up for OTM calls as well. Solar companies are a great example. Below you will see my make shift chart of SOLF skew versus IBM skew. The red circles draw your attention to the upside skew in SOLF unlike IBM. Click the image to enlarge it.

    -- Go to the blog to see the charts --

    You can read the details, trades, prices, charts and vol on my blog:
  2. where are you getting 200-300 vol numbers on SOLF ?

    both cboe and ivol print is around 70 ( flat across the strikes , no skew)
  3. head asplode

    oh, and link broken :(
  4. Where are you seeing 16k+ in volume?
  5. livevol_ophir

    livevol_ophir ET Sponsor

    If the OTM puts trade on the offer (say the 5 puts trade 0.05) you get that vol. Of course these options are no bid so defining a vol is hard. The pointof the article was the call skew - which is correct. I guess I could have just chopped the strikes below 7.5 off - would have been a bit clearer.

    Note with stock below 10

    12.5 calls are bid
    7.5 puts are no bid

    Again, and the stock is closer to 7.5 than 12.5.

    That's a reverse skew.

    Thanks for your feedback.
  6. livevol_ophir

    livevol_ophir ET Sponsor

  7. livevol_ophir

    livevol_ophir ET Sponsor

    6900 Jan 10 Calls
    5800 Feb 10 Calls
    1000 Feb 12 Calls

    That's about 14,000 OTM calls. The rest are a smattering.

    Thanks for your feedback.

    FYI to all, this blog was picked up and published by Bloomberg.