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CBOE SKEW INDEX at Highest Level Ever

Discussion in 'Options' started by N N, Oct 13, 2015.

  1. N N

    N N Well-Known Member

    I know it's not a typical position but with S&P SKEW at all time highs, just wanted to get some thoughts from the forum on this:

    1) Skew is negative for butterfly pricing so avoid M3s, BBs for now? What if you have one on prior to SKEW ramp, take it off?

    2) Is Risk Reversal (sell put, buy call, short stock?) a good way to play SKEW reversal without exposing to large losses? How about a reverse Butterfly - worth it? I know 1x2 is more common but now you have naked risk on downside.

    Love to hear what others are thinking
  2. Kevin Lee

    Kevin Lee Well-Known Member

    Hi NN,

    Personally, I find little correlation between the CBOE SKEW and the performance of my butterfly trades. Instead, I think the absolute IV level makes more sense. In general, income options trade is hardest when HV >> IV or in increasing IV environment. All else equal, I'd much prefer to enter a trade when IV is relatively higher. Extremely low IV is the worst environment to enter a trade - for that, I might reduce my trade size. The SKEW reading can be low or high for given a specific IV. It might have an impact on the butterfly price but as long as I get a fair price, the SKEW index will not have an influence on my entry decision.

    Having said that, the skewness of the IV slope does have an influence of the type of adjustments that I'll make. However, for that, I will not look at the CBOE Skew index. It's not precise enough. I'll do my own measurement of the ratio of the IVs between the long leg and the short leg of the butterfly.

    Rick, N N and Gail like this.
  3. GreenZone

    GreenZone Well-Known Member

    Kevin, could you please give some examples of how you would choose adjustments based on the vertical skew.
  4. Kevin Lee

    Kevin Lee Well-Known Member

    Sure... One common example is when market rebounds from a sell off. IV goes from high to low. IV skew goes from flat to steep. Example :


    Usually IVs above the market drops more than IVs below the market, making the IV curve steeper. As shown in the table and chart above, IVs above 1210 ATM declined more in percentage term as well as in absolute term than those below market. Take note that although RVX dropped 1.9pts or 8.66%, the IV drop below market is far milder. Whereas the magnitude of drop above market increases with strikes. Therefore, anticipating such a shift in IV skew, the rational thing to do is to tuck the longs below market and push the shorts to above market, ie a bullish spread.

    Example - if I want to fix a negative delta problem and I see that the skew is relatively flat then I would choose a bullish spread with the long leg below market and short leg above market. In this way, as the market rebounds, the short leg IV will decline more than the long leg IV as market rebounds. Or in such a situation, I could kick in the right leg of the existing butterfly instead shifting the butterfly shorts upward. This adjustment is equivalent to an above the market bullish spread that places the short leg of the adjustment spread further up the strikes to benefit from a bigger IV drop.

    Or in other situation, if I want to enter a butterfly, then I'd do a BWB instead of regular butterfly. That's because this BWB is equivalent to a normal butterfly with an embedded bullish spread on the right side; therefore it will achieve the same benefit of a right side IV crush.

    So.... IMO, knowing how IV skew changes is important. With that we can make better decisions on where to place the long and the short options. IV skew doesn't always behave the exact same way but the patterns do repeat frequently enough for us to benefit from.
  5. Georges

    Georges Well-Known Member

    I suppose Optionvue include the CEV and vertical skew in his projected prices,
    and T + x lines in P/L graph.

    Does Optionvue also include "IV skew goes from flat to steep" in his volatility model ?
  6. GreenZone

    GreenZone Well-Known Member

    OV can show you the horizontal skew graphically, as you can see here:

    But I think what you're referring to is being able to graphically see the vertical skew, and see it as time goes by.
    That's something which I've only seen in LiveVol.
    OptionVue doesn't have that ability.....at least no way to do it easily (I guess you could use BackTrader to rewind time and then compare the graphs manually, but that would be a royal pain).
  7. Capt Hobbes

    Capt Hobbes Well-Known Member

    IB has a form of it, under Analytical Tools > Option Analysis > Volatility Skew > Time Lapse Skew (in the Classic TWS UI). It doesn't let you see the curve at an arbitrary point in the past, just the current one and at some days in the recent past. I also found it doesn't always work after hours.

    But given TOS and Excel, it's not too difficult to roll your own like Kevin does, capturing the current curve as part of your daily trade check.
    Kevin Lee and GreenZone like this.
  8. Kevin Lee

    Kevin Lee Well-Known Member

    As i understand, OV does not include skew changes in its modelling.

    To track the skew change, I find it quite easily to just use TOS DDE to capture and plot the data on Excel. I'd just copy and paste as values once a day to capture historical and then compare with the real time curve. Pretty easy. No need for expensive software.
  9. Georges

    Georges Well-Known Member

    Thank You for the answer.
    Last edited: Oct 16, 2015
  10. GreenZone

    GreenZone Well-Known Member

    Kevin's analysis from above, in terms of noticing that the IV of deep ITM puts tend to reduce by a larger factor when IV drops, is an interesting point.....but it may also need a bit of further analysis before we start jumping to conclusions of the best adjustments to take advantage of this observed behavior.

    What I'm getting at specifically is reminding you that the IV only has an impact on the extrinsic value of an option.
    Deep ITM options will have a relatively small amount of extrinsic value, as a percentage of the total value of the option.
    So even though the IV may reduce to a larger extent for deep ITM options, the fact that the amount of extrinsic value these options have are relatively small, means that these things may balance out.
    It could therefore potentially be possible that an ATM option may end up being more affected by the drop in IV compared to a deep ITM option, even though the IV% drop is smaller.

    Something to think about.....(and test)....
  11. Kevin Lee

    Kevin Lee Well-Known Member


    This is a good reminder. I've made a lot of assumptions in my original message because I'm so used to looking that the skew. The selection of strike is important and you need to know when a skew is flat and when it's considered steep. You want margin of safety. The critical thing is to backtest and monitor the skew changes long enough that it'll become intuitive.
  12. Capt Hobbes

    Capt Hobbes Well-Known Member

    A couple weeks ago in a round table JL was speaking how an ATM butterfly responds differently to skew than one far below the market, and how that means you want to roll up while the market is still moving and the upper long IV is high. Here are some some simulations I made to put some visuals and ballpark numbers behind this concept.

    Here is a theoretical price of a 50-point wide ATM butterfly 30 DTE with the center strike and price of the underlying both at 1160. The center strike IV is fixed at 20%. The two horizontal axes are IVs at the left and the right long strikes. Both vary from +/- 10% to +/-20% (relative to the center IV, that is +/-2% and +/-4% in absolute IV terms). A uniform skew, with the lower and the upper long IVs changing by the same amount relative to the center, corresponds to the straight line starting in the nearest corner of the surface (10% skew) and going away from the viewer into the opposite corner (20% skew).

    BF IV and skew ATM.PNG
    According to this simulation, an ATM butterfly is pretty much impervious to uniform skew. In contrast, here is a butterfly in an M3 roll position, with the market 10 points above the upper long.
    BF IV and skew 60 below.PNG
    Here the value drops a lot on the skew steepening, especially on an upside IV decrease (upside skew increase).

    For a ballpark idea of what amounts we are talking about on skew changes and as well as uniform IV changes (when the entire curve is moving up or down), here are some actual numbers from the simulation. For each butterfly, the top line shows prices for 10% and 20% IV skews with the center IV of 20%, and the absolute and relative value change going from 10% to 20%. The second line is the same butterfly with the center IV increased to 22%, and the wings IV increasing so as to maintain the same skew of either 10% or 20%. The gray numbers between the 20% and 22% lines are the absolute and relative change in price going from 20% to 22% IV while maintaining the skew.
    BF skew numbers.PNG
    This underscores JL's point of the "roll up" butterflies being very different from those centered closer to the money.

    Now, the uniform skew used in this model is rarely the reality, which is why I used the word "ballpark" a lot. But hopefully the price surface graphs illustrate why we can't replace the actual IV curve with just an IV index and a skew index.
    N N likes this.
  13. Georges

    Georges Well-Known Member

    "A couple weeks ago in a round table JL was speaking how an ATM butterfly responds differently to skew than one far below the market ..."

    Round table from date ?
  14. Capt Hobbes

    Capt Hobbes Well-Known Member

    October 7.
  15. N N

    N N Well-Known Member

    Is there a link to the video?

    So if I understand this correctly, ATM fly's aren't as sensitive to skew but OTM fly's are more sensitive and especially on the higher strikes?
  16. Capt Hobbes

    Capt Hobbes Well-Known Member

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