Does the smile flatten or get steeper after volatility increases?

S

Sig

For indexes, specifically SPX and RUT, does the smile get steeper or flatter during times of high volatility? For example, last week's high volatility seemed to flatten the smile, i.e. a short dated option 50 points off spot had a similar implied vol to an ATM option where as three weeks ago it would have had a higher implied vol. Was that just last week, was I imagining things, or is that generally the case? It seems like a simple question but I can't really find any literature examining it with any rigor, anyone have any references for me? Thanks in advance.
 
Sig:
This topic is beginning to get traction. Some people are digging into this subject. I am still studying it and have no "take-aways" yet. Apparently the behavior of the steepness with respect to volatility has changed in the last few years. I have heard of theories that seem logical, but nothing definitive. This is of peripheral interest to me currently.
An individual on another site has some interesting info on the subject. If you like, I may post his work privately.
 
Sig said:
For indexes, specifically SPX and RUT, does the smile get steeper or flatter during times of high volatility? For example, last week's high volatility seemed to flatten the smile, i.e. a short dated option 50 points off spot had a similar implied vol to an ATM option where as three weeks ago it would have had a higher implied vol. Was that just last week, was I imagining things, or is that generally the case? It seems like a simple question but I can't really find any literature examining it with any rigor, anyone have any references for me? Thanks in advance.
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Curves steepen when markets have gap risk vs simply an expectation of vol going higher. You can think of ATM vol representing the overall expected volatility level and the skew to represent the probability of a large outlier. For example, individual stocks often have huge skews going into earnings but the stock itself actually becomes very quiet going into the report. So stat vol is almost zero and will be expected to be zero "after the earnings gap" but the gap itself, a one time event, will be priced into the skew.
 
Maverick74 said:
Curves steepen when markets have gap risk vs simply an expectation of vol going higher. You can think of ATM vol representing the overall expected volatility level and the skew to represent the probability of a large outlier. For example, individual stocks often have huge skews going into earnings but the stock itself actually becomes very quiet going into the report. So stat vol is almost zero and will be expected to be zero "after the earnings gap" but the gap itself, a one time event, will be priced into the skew.
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That's what I've seen as well, it's like the VIX futures going into backwardation after a big move up. Thanks for the thoughts.
 
stepandfetchit said:
Sig:
This topic is beginning to get traction. Some people are digging into this subject. I am still studying it and have no "take-aways" yet. Apparently the behavior of the steepness with respect to volatility has changed in the last few years. I have heard of theories that seem logical, but nothing definitive. This is of peripheral interest to me currently.
An individual on another site has some interesting info on the subject. If you like, I may post his work privately.
More...
Would love to see it. You'd think some academics would have studied it but I could only find it mentioned as a second or third order effect without much further study given as part of studies about something else.
 
Maverick74 said:
Curves steepen when markets have gap risk vs simply an expectation of vol going higher. You can think of ATM vol representing the overall expected volatility level and the skew to represent the probability of a large outlier. For example, individual stocks often have huge skews going into earnings but the stock itself actually becomes very quiet going into the report. So stat vol is almost zero and will be expected to be zero "after the earnings gap" but the gap itself, a one time event, will be priced into the skew.
More...

I think it also matters if it is a binary event, where the unknown is gone after.
 
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