Taking advantage of index skew

Discussion in 'Options' started by jj90, Jul 19, 2006.

  1. jj90


    If you look at DIA or OEX or BBH or some index equivalent, the premiums to the downside don't drop as hard as the premiums to the upside. DIA for example from today's close has significant premium in the AUGs 5 strikes away down, while 5 strikes up there is virtually none. Of course the market has been selling off and there is the effect of index puts inflated due to skew, but I remember back in April when vol was lower the same effect still held, albeit over less strikes.

    The same doesn't occur in equities, even heavily skewed ones such as KCI where the AUG and SEPT series are trading with a minimal difference in some strikes. Even if the vol smile in an equity is giving insanely high IV numbers, especially to the downside, premiums are even falling away from the ATM strike.

    Now I've been recently trading short term flys to the downside on the 3 majors, and upon review of my trades, if I were to construct the same fly to the upside, the debit would be larger and the R:R worse. This is not an argument to sell naked OTM index puts ala Niederhoffer, but there's gotta be a way to take advantage of this.

    So following the uneven distribution of premium in such indicies, i was thinking something along the line of a cross synthetic. I short index calls and long constituents puts on a bearish sign, and reverse that on a bullish sign. Not really disp trading, but the best I can think of right now.

    If this made sense to you, I'd like to get your opinion on it.
  2. It's a form of replication using risk reversals. Good idea.
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  4. Well, Riskarb has given his seal of approval so not much to add :D

    There was a minor discussion of split-strike combo's here though it was in the context of hedging short gamma positions. Some of the points discussed are still pertinent.

    Good luck!