December 10, 2019

Not All Strikes Are the Same

Volatility skew refers to the fact that options on the same underlying asset, like a stock or a future, with different strike prices, but which expire at the same time, have different implied volatilities. Implied volatility can be explained as the uncertainty related to an option’s underlying stock, and the changes triggered in different options’ trading prices.

Puts on a typical equity or ETF skew curve will have higher volatilities than calls.  This is intuitive because of the way that prices tend to move in this type of market.  When equities go up, they tend to go up in a slow, measured fashion.  When they go down, it tends to do so violently.  There is more fear of the downside because the natural position of a market participant is long the underlying asset.

Below you will see a skew graph of the Russell 2000 Index ETF, IWM.

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about the author:

Mike Shorr

Since 1994, Michael has been an on-the-floor market maker, Vice-President of Interest Rate Derivatives for Knight Financial Products and Director of Education and Options Instructor at Trading Advantage. He makes the oftentimes complex world of options and trading accessible to the novice and advanced trader alike. Michael has a Bachelor of Science degree in Statistics and Finance from the University of Illinois Champaign-Urbana. He presently is Director, Trader Education at ProsperTradingAcademy.

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