One simple example with a vertical would be to assume that it is approximately like pricing a binary (the replicating portfolio for a binary option is an infinitely tight vertical). Say you want to price the 100 / 110 call spread (numbers made up): Call Spread = (BS Value (100, ATM vol) - BS Value (110, ATM vol)) + Vega (105 strike) * (Skew Slope). So if the skew were negatively sloped, and the 100 call traded 1 IV point over the 110, then the "Skew Slope" factor to multiply the midpoint vega by would be 1%.
thanks understand "skew" could the skew in those strikes be positive ? very specific circumstances I suppose. If you thought a commodity will go up, would you buy options or just buy underlying ?? thanks
thanks. so if correlated with 30 ATM options are they not undervalued? Options shape assumes a log normal distribution and the tails are not all that fat, when in fact they "could" be and quick ( I saw a commercial for wisdom tree put writing strategy, would like to learn what they write actually.. Cant imagine this is a good strat other than for a short portfolio ?
If I thought it was going to go up, I'd probably just buy the underlying. Yes, skew can be negative, positive, flat, or symmetric (smile). Market dependent. Read the white paper on the CBOE put index (ticker: PUT). The index replicates the return of selling cash-secured ATM puts on SPX over a constant synthetic tenor. There is also a 2% OTM put index I believe. Either way, there's info out there on historical returns, volatility, and relative performance to other asset classes. I think you'll find some good information there.