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Volatility Smirk Into Binary Events

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Volatility skew is the difference in implied volatility among various strikes of calls and puts and gives an indication of directional ‘fear’. Since equity indices tend to fall faster than they rise, the premium paid for puts is usually bid up more than that of calls that are equidistant from the ATM strike. Thus, there is a higher IV priced into puts. This can be seen in the implied volatility smirk which has a greater slope for out of the money puts compared to out of the money calls for index options.

Considering the volatility skew measures traders’ perceptions of risk, we observe the implied volatility skew approaching two binary events; an earnings announcement and the U.S. Presidential Election.

In both scenarios, volatility increases more at the wings than at the money. This results in more of those options’ prices being composed of implied volatility (fear), which benefits tastytraders who profit from time decay and iv crush.

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