Hello, I know there are a lot of very knowledgeable and experienced option traders in the forum so I am hoping someone can help me understand this. What is the prevailing consensus for Volatility Surface dynamics? In other words, when the underlying rises do the options for it behave as sticky strike or as sticky delta? what about when it goes lower? And for violent price moves? I think I understand term structure a bit better but skew still baffles me. The underlyings I am interested in learning as much as I can about are Individual Equities and Equity Indices. The reason I am asking this is because I have (of course) been burned using multi-legged spreads (long butterflies) even though in some cases IV has gone down (but not consistently for all the options in my butterflies). I understand that it all depends, and it can change any minute and past performance etc etc etc but I would like to get at least a quick rule of thumb as to how the different volatilities (skew and term structure) behave especially in relation to the underlying. I have read many of the usual suspects (Sinclair, Bennett, Taleb, etc) and I still can't get a clear picture as to how it behaves. Thanks in advance
For equity index options it's mostly sticky strike (or, better described as "beta-vol"). When the vol is low, though, indices start to behave in a sticky-delta way in a rally.
If you think about the IV skew that is displayed usually (not always though) by Individual equities and equity indices: You can see that (usually) the ATM IV is the lowest one for that particular maturity (in that example it would be 60). The question here is what happens when the price of the underlying changes. For example, let's say that the price drops to 45. Sticky strike would indicate that the IV for that 45 strike would be the same as it was before the underlying dropped. The only difference would be that the 45 is now the ATM and the rest of the curve would change but the 45 strike retains the volatility it had. For sticky delta, the 45 strike (after the drop) would have the same IV that the 60 used to have since the 45 is the new ATM (like the 60 was before). The whole curve would change as well. The problem here is that in real life what happens is a combination of both (with a potential additional shift in the whole curve and even a steepening or flattening of skew). Needless to say, if you have positions in several strikes it's hard to anticipate what is going to happen to all your IVs since they will move in some cases almost independently. This is where you think for example that you buy a butterfly in high IV hoping IV goes down and when it does, the actual profit/loss is different than what you anticipated.
1) "Sticky" 'strike' or 'delta'? It's mostly "sticky" implied vol. 2) "Sticky" is a function of volume -- the less volume, the more "sticky" will be pricing -- thereby, 'delta' and the volatility implied.
It describes what happens to the implied volatility of a fixed strike option when the underlying moves. Let's say the stock is at a 100 and there are 3 strikes you care about 95, 100 and 105 with implied vols of 12, 10 and 7 respectively. You buy a 105 call because you think the vol is cheap and then the underlying moves to 105. In a sticky strike dynamics, you would expect the volatility on a fixed strike to stay the same at implied vol of 7. In a sticky delta dynamics you would expect the whole vol skew to move together with the underlying - so now that 105 is ATM, it's going to have the implied vol of 10. In general, MMs usually mean that there is a path for ATM vol that is different (usually steeper) from the skew. So you skew stays fixed but it goes up and down with ATM vol which moves along it's beta slope. Say whaaaat...
So that's sticky delta behaviour - for example, you buy an SPX call at 6 vols and when the market rallies vol actually goes up.