Most option traders know that puts trade for more than calls and this is calledbut we are here to help you visualize this for a more thorough understanding and additionally to introduce you to the skew index. Dr. Data (Michael Rechenthin, Ph.D.) is here to improve your options health.
Dr. Data began with the distribution curve of market moves. It's clear that markets have many more huge down moves than up moves. This is why there is skew. Our good Doctor followed that with a graph from January 20, 2016 after the S&P 500 had declined by 9% in just two weeks. It showed the SPY options with 30charting the versus the strikes distance from the closing price (with the closing price in the center). He explained the chart and its importance. The next chart from the same day is more like what one usually sees as Prices replaced on the y axis . The skew is still apparent.
Two other charts of the same setup as the last two were displayed next. The data was from a normal day from a couple of years ago. Here one could see the skew “smile”. The skew is still obvious but is nowhere near as pronounced as in the earlier pair of charts.
The Skew Index was then explained. The Skew Index measures the slope of the implied volatility curve. It is used to judge the “perceived tail risk”/”Black Swan” risk. A higher slope means the market perceives a greater risk of a large move. Dr. Data put this into historical context, where one can find the number and explained that it is not a real time number but is from the previous day.
Mike's final display was a table showing a column of Skew Index readings from a high 145 down to 120 in five point increments. The other columns were the percentage chance of a 2 and 3move for those readings.
Watch this segment of the “Skinny on Options Data Science” with Tom Sosnoff, Tony Battista and Dr. Data for the valuable takeaways and a better understanding of Skew and the Skew Index.