Hello Guys, I am wondering if some of you use the shape of the volatility smile to make bets on the underlying... By making markets and choosing a volatility level for lower and higher strikes, MMs tend to make public what they think of the future market or more exactly where the greatest risk of large movement will be...So do you use this information to trade the underlying? I have forward tested MM views on commodities with mixed results so far... So what is your opinion? Do MMs have a clue where the market is heading? Thanks.
Smile reflects general market sentiment, not really MM sentiment. MMs aren't almighty beings whom structure smile as they see fit. Im surprised they even make money considering how tight the spreads are in some instruments
In the products I trade( grains ), I doubt the smile originate from a broad consensus. But rather a few MMs start making markets and settle their smile where it doesn't attracts too much "smart" prints from the informed buy side.
when you are talking about the smile I assume you are talking about the skew of the vol? For me the smile is more about the risk profile you actually have from either long vol or short vol. Never the less.... Most MM have the same idea as anyone else regards where it might be going. The big issue is managing their risk and hence they skew options largely based either on supply and demand - because it makes sense or because the crowd thinks it makes sense. There are plenty of times MM have to cross theo spreads to adjust their own risk profiles. I never really traded grains so i dont know specifics there but in equities especially some less liquid instruments often even if you have a view on a stock you have to make sure you dont get taken out of the view and so you price accordingly. I assume the grains are the same.
It's my understanding that the smile (vol skew) came about after 1987, when the MMs got their head handed to them. Since then "THEY" have skewed us!