After some more reading on volatitlity I'm finding it difficult to put all the pieces together. I think I'm getting the hang of some things, whereby vegas (is the measure of volatility) are greatest ATM (most sensitive) then OTM or ITM options. As volatility increases options prices increase and decrease as volatility decreases. The things which I can't seem to put together are the Skew levels away from ATM and the previous ranges by looking at Historical Volatility and Implied volatied over a certain period of time (30 days for example). Can someone help me out in how to work out a Skew on a particular market (RUT for example) using the free calculator on http://www.ivolatility.com/calc/ After reading some books on this, they talk about increasing the strike prices, but at the same time increasing the volatility? I dont get how are they getting the volatility numbers from. Is there a reference in here that I can help for this please? Regards SAA
The Jan 08 skew using ivolatility data. Just plot out the iv vs. k from the table; no need to use the calculator.
Timbo, Many thanks for that. In this instant one can see the Volatility Skew amongst the different strikes. In this case the OTM puts have a higher IV. What is considered normal, I have read that a "V" shape is normal? Cheers SAA
Should be flat for normal; the smirk is typical. Attached is aapl iv's from back in the summer (7/8/07) -- each curve is a day.
Flat is normal in the magical mythical Black Scholes Merton world where vol is constant, no txn costs, no taxes, continuous trading, blah, blah... Smile was typical pre 1987 crash. Nowadays the smirk is more typical - simply put the market is pricing some other risk not priced by the BSM model.