"Skewed" Pricing in Options | Skinny on Options Data Science
Apr 22, 2016
Skew is an options trading term that describes the fact that the implied volatility of options on the same stock and in the same expiration are different from strike to strike. Typically, the further OTM strikes will have higher implied volatilities than less OTM strikes, and OTM puts will have higher implied volatilities than OTM calls. In that regard, skew accounts for the fear that markets crash down more frequently than they do up. That fear is represented in the "skewed" pricing of options - meaning puts are more firmly bid than calls because of the extra risk premium inherent in these contracts.
"The Skinny Around Skew," an episode from The Skinny on Options Data Science series, recently took on a wide-ranging discussion on skew.
On the show, hosts Tom Sosnoff and Tony Battista were joined by Dr. Data (Dr. Michael Rechenthin) and together they presented a clear illustration of skew and how it functions in the options marketplace.
Dr. Data first presents a chart of the monthly returns in the S&P 500 going all the way back to 1990 that shows the frequency of instances in which the market has moved by a given percent.
The data demonstrates that there are more instances in which the S&P 500 has moved down 10% or more as compared to up. This helps explain why a natural bid exists on the put side that pushes premium higher.
Dr. Data shows the range of prices for calls and puts across the option chain in the S&P 500. As you can see below, the puts are priced well above the calls even when the distance from the closing price is equal:
The above is a clear representation of skew observed "live" in the marketplace. Of course, the higher premiums will translate to higher implied volatility. This is the reason we often observe lower implied volatility on OTM upside calls as compared to OTM downside puts.
Dr. Data presents two different samples of options prices in the S&P 500 to reinforce his point. The first is taken from prices observed after a sell-off in the S&P 500, while the second reflects skew pricing from a “normal” day. As you might expect, skew becomes even more pronounced when the market is moving down.
If you want to learn more about skew, there are more tastytrade resources below.
If you have any additional questions, we also encourage you to contact us at firstname.lastname@example.org.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
May 6, 2016
Earning a certain average profit per month by selling premium is something of interest to many investors and traders. Until now, no one knew how much extrinsic premium needed to be sold to generate a targeted average monthly profit. We’re about to change that.
May 4, 2016
One similarity tastytraders share is enjoying stories from market veterans who helped pave the road we hope to build upon. Tom recently sat down with his uncle, famed investor Martin Sosnoff to discuss how Martin became involved in markets and his approach to investing.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.
Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.