• That was then, this is now. For option
traders, now is a good thing, particularly
when it comes to volatility (vol). Options
volatility is typically divided into two time
periods: before and after the 1987 crash.
Before the crash, at-the-money (ATM)
options in a given stock
traded with the same implied volatility (IV) levels as
those that were out of the
money (O TM). This meant
that OTM put options
were priced far below fair
value. But then the market
crashed, and traders learned
an expensive lesson: Never sell puts so
cheaply ever again.
But raising the vol of every option, espe-
cially those at or near the money, could lead
to slow death by time decay. The solution
was to give each options strike a different,
and adequate, IV level. Thus, volatility
skew was born.
TRACKING VOLATILI TY SKEW VIA THE
There are different ways to track skew. But
one approach is to go to the option chain
and compare the IV levels of the 30-delta
put and 30-delta call. By subtracting call
vol from put vol, you can see any changes
in market maker sentiment over time.
Note that you may not always find options
displaying exactly 30 deltas, so just use the
value closest to 30.
The option chain in Figure 1 shows a
30-delta call and a 29-delta put (close
enough, although you could use 31). The
difference in IV is 3.98% in favor of the puts,
which tells us the market is more con-
cerned about downside moves rather than
Traders often track these values to find
sudden changes in the skew level. If the
difference between the call vol and put vol
grows more negative, the market may be
anticipating a downside correction. If the
difference is positive, the market may be
expecting a rally of sorts.
VOLATILI TY SKE W: A VISUAL
Within each stock, vol is different at
every strike and expiration. To see this
difference, select an expiration and explore
the range of vol levels across all strikes.
To find volatility skew for a given stock,
fire up the thinkorswim® platform from
TD Ameritrade, then:
1—Go to the Trade tab.
2—At the bottom, below the option chain,
select Product Depth.
3—Under the Show menu, select the type of
options you want to see (All, Calls, Puts,
OTM, Average). Typically, call and put vola-tilities that share the same strike are similar, so if you select the OTM curve, it gives a
more robust picture of volatility skew. You
can select one expiration, all of them, or
anything in between.
4—Select all strikes or a smaller range of
You’ll see a graph of the volatility curve,
which if balanced, is often referred to as
a “smile.” Sometimes, you may notice the
slope for O TM puts may be steeper than the
slope of O TM calls (a “smirk”). This implies
the marketplace may be fearful of a correction. If the upside slope is significantly
steeper than the downside slope, it may
signal that traders are bracing for a possible
sudden upside move.
Volatility skew is no crystal ball, but it’s
a tool that can help you analyze what the
market might be thinking.
For more on the risks of trading and trading
options, see page 38, #1– 2.
See Skew Without
SEASONED • BIG IDEA: WHERE DOES THE MARKET ANTICIPATE
RISK? COMPARING EQUIDISTANT OUT-OF-THE-MONEY
PUTS AND CALLS MAY GIVE YOU SOME INSIGHT.
FIGURE 1: Tracking skew. On the Analyze tab on the thinkorswim® platform, type in the symbol for the underlying, then bring up the option chain. For illustrative purposes only. Past performance of a security does not guarantee future results or success.
Words by Mark Ambrose