Volatility skew is the difference in Implied Volatility (IV) between out-of-the-money (OTM) calls and puts with the same expiration date. It signals market sentiment by showing whether traders are paying more for downside protection (puts), or upside potential (calls).
As a result, this type of trading action creates a “skewed” shape in the volatility surface instead of a flat line.
Let’s look at two examples from yesterday (Tuesday, March 3rd):
- For the SPY, the 1% OTM put closed at $3.50. The 1% OTM call closed at $2.30
- For Invesco (QQQ), the 1% OTM put closed at $4.50. The 1% OTM call closed at $3
These are both options that expire this Friday (March 6th)
Volatility skew is the centerpiece of a bizarre theory Scott Bauer recently revealed.
Amid the ongoing conflict in Iran, many traders braced themselves entering the trading week. While the market had a surprisingly stable performance on Monday, it was down big yesterday morning. Remarkably, the market made a respectable rally to close out Tuesday’s session, recapturing a good amount of its losses.
Yesterday’s session left a lot of traders scratching their heads. Scott’s theory might shed some light on the market’s performance this week.
Scott joined Oliver Renick on the Chicago Future of Finance Podcast yesterday, where he laid out the details on his volatility skew theory.
The analysis, insights, and strategies shared by Prosper Trading Academy’s coaches in Prosper Insider are strictly for educational and informational purposes only. All content reflects the personal opinions of the coaches and should not be construed as specific investment advice or recommendations. Any examples discussed are illustrative in nature and do not represent actual live trade signals or instructions to buy or sell securities. Trading involves risk, and individuals should carefully evaluate their own financial situation before making investment decisions.
Scott’s breakdown covers:
- How volatility skew could be impacting this week’s market performance
- The major indices where he’s seeing a bearish volatility skew
- If it could be a sign that long-term institutions are hedging their long positions
- Why he believes this volatility skew could be a “trader’s haven”
- The big difference in call/put pricing for the S&P 500—and why he believes it’s something people should be watching
