I am new to options and came across the term "skew trade". Please enlighten me. What kind of position is this? Thanks.
not an expert here... but in general the "skew" refers to the difference in implied volatility ( IV or vol's) sometimes one month to another other times in different strikes or between the put/call so a skew trade is any trade that attempts to "use" the skew...calendar is just one..
Just to elaborate to what donna said. skew involves looking at say, an IBM 80 put April expiration is roughly 17.6%IV. That same put but another expiry, say July has an IV of 16%. These options are said to have a positive 1.6% IV skew. In general larger IV levels in near month options compared to farther out options usually tells most traders that a big news item should be coming out on that particular stock(earnings,mergers,fda,etc). Unfortunately, many think this is a good environment for a calendar spread. Their rationale is selling the near month brings in a credit or 'fat premiums' because IV levels are high, compared to buying 'cheaper vols' in far dated month. What they are missing is most large IV skews are there for a reason, and there is a big gap or expected move in the stock, and this absolutely kills a long calendar spread. I find double diagonal spreads work better for the so called 'skew trades'. I hope this helps.
In my dealings, skew was the difference in IV between strikes. For example. Buy IBM 90 line on a 35 vol Sell IBM 80 line on a 42 vol. If the atm usually trades near historical, then one would be able to capture this with some careful gamma scalps.
Hmm, if that could be 'captured' so easily, then the computers would be doing it, and it wouldn't be there for you to capture.
Never said easy. Probably, you would have to hold close to expiration. Then the fun would begin. Hopefully you would be able to withstand the gap thru your short strike.
In my experience, same month diff. strike vols is referred to the 'smile'. I suppose it's just a diff. use of semantics tho. And all months at different strikes is the vol surface. Someone correct me if i'm off base here.
btw, straddler, wouldn't it be easier to scalp gamma if historical vols were higher than IV? That is, if underlying moves 'quicker' than IV, that would in turn give more opportunity? I find the gamma scalp fascinating, racing theta. Do u ever short straddles to gamma scalp?
smile. yes that was the whole picture. usually you would set up a "skew" trade if the smile was crooked so to speak. in regards to shorting straddles in order to scalp gamma, that is not for me. I usually try to offset the sale with a buy somewhere along the curve. it is nice to collect that theta, but sometimes the vol never implodes so you have to sweat it out and/or take the hit. you will know if it is a bad sale soon enough.