Monday, July 18, 2011

Options 101: Skew

Skew, also referred to as the "smile", is the difference in implied volatility levels of single cycle options. There are two main groups of skew, horizontal and vertical. Horizontal skew shows how implied volatility changes across time and vertical skew depicts the change in implied volatility across strikes.

Although there are many beliefs as to why it exists, in general, skew is a product of supply and demand. Knowledge of skew shapes can help traders identify opportunity and steer clear of danger when spreading in various markets.

Using option analysis software, one can plot implied volatility as a function of both strike price and time to maturity to create an implied volatility surface. This allows traders to quickly determine the shape of the skew and identify any areas where the slope seems irregular.

*Special thanks to Option Radar, BMO Capital, MEB Options, LiveVolPro, CBOE, Option Monster, T.O.P. group, and all of the options desks and traders we work with to provide the option flow!No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.

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