Fallacy in option pricing?

[wilburbear]

Now that we see the Fed, and our government, will intervene to attempt to hold up falling equity prices, should out of the money puts in equities and equity indices, continue to trade with such a steep slope for implied volatility?

Or should the steepness of the slope in implied volatility for puts now decrease to more accurately reflect interventions to hold up equity prices?

 

[scriabinop23]

Quote from wilburbear:

Now that we see the Fed, and our government, will intervene to attempt to hold up falling equity prices, should out of the money puts in equities and equity indices, continue to trade with such a steep slope for implied volatility?

Or should the steepness of the slope in implied volatility for puts now decrease to more accurately reflect interventions to hold up equity prices?

long portfolio holders collar the market (sell otm calls to buy slightly otm puts) and this creates the volatility skew you see.

This skew will probably balance out a little as the collar trading stops (assuming long managers get a little more comfortable with things).

 

[Eliot Hosewater]

Who do I see about losing money when the Fed injected liquidity week before last?

 

[xflat2186]

There are always natural buyers of puts in the market place which Scria already eluded to. Large firms buy vast numbers of index puts which creates the volatility skew and then those firms who sell them need to hedge that risk so they disperse the risk by buying puts in other areas of the markets. The games gotten even more sophisticated over the last 10 years with the introduction of many new products like options on the VIX futures.

Essentially the skew will always exist because of the geopolitical risk in the market place but there is a case to be made perhaps for that skew being smaller then in the past because of the globalization of the worlds equity markets. We'll have to see over a number of years.