The public often uses the VIX
as the standard measure of “fear” in the overall market. Some prefer to look at option skew instead. Skew tells the investor how much out-of-the money puts are being bid up versus out-of-the money calls.
as the standard measure of “fear” in the overall market. Some prefer to look at option skew instead. Skew tells the investor how much out-of-the money puts are being bid up versus out-of-the money calls. If an investor is scared about the downside, then they buys puts. If an investor thinks there is room for upside, then they are willing to buy calls. SurlyTrader posits that when the difference between the implied volatilityof OTM puts dwarves OTM calls, then investors are fleeing for the exits. As the chart below shows, on May 20, 2010, the skew of 3-month options hit a five-year-high.
Depending upon valuations and underlying market conditions, the skew can signal either prescient fear or undue panic. Consequently, if the spike on May 20th is a positive signal, then we should soon find our own local bottom.
SurlyTrader advises: "If you believe we are close to a bottom, selling OTM puts and buying OTM calls looks very attractive with a steep skew. Always think about selling insurance when the building is on fire rather than buying insurance after the major damage has already taken place."
posits that when the difference between the implied volatilityof OTM puts dwarves OTM calls, then investors are fleeing for the exits. As the chart below shows, on May 20, 2010, the skew of 3-month options hit a five-year-high.Depending upon valuations and underlying market conditions, the skew can signal either prescient fear or undue panic. Consequently, if the spike on May 20th is a positive signal, then we should soon find our own local bottom.
SurlyTrader
advises: "If you believe we are close to a bottom, selling OTM puts and buying OTM calls looks very attractive with a steep skew. Always think about selling insurance when the building is on fire rather than buying insurance after the major damage has already taken place."
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