Meaning of put/call price difference

JimFalcon · Nov 1, 2012

Hi,
I've noticed a huge price difference in the price of puts vs. calls on SPY at the same distance from strike. Recently, for example, a June 22 '13 107 put was about $1.33 while a 178 June 22 '13 call was only about $0.08.

First, is this what is meant by volatility skew?

Second, what is the significance? Is it just a random phenomenon which will eventually revert to the mean with little or no consequence? Does it suggest the market is expecting a decline so pricing puts higher?

I read one article which said that when a stock does this it is bearish. Of course SPY isn't a stock, so I'm not sure this would apply.

Thanks in advance for any insights.

Jim

1245 · Nov 1, 2012

Quote from JimFalcon:

Hi,
I've noticed a huge price difference in the price of puts vs. calls on SPY at the same distance from strike. Recently, for example, a June 22 '13 107 put was about $1.33 while a 178 June 22 '13 call was only about $0.08.

First, is this what is meant by volatility skew?

Second, what is the significance? Is it just a random phenomenon which will eventually revert to the mean with little or no consequence? Does it suggest the market is expecting a decline so pricing puts higher?

I read one article which said that when a stock does this it is bearish. Of course SPY isn't a stock, so I'm not sure this would apply.

Thanks in advance for any insights.

Jim

Only part of the value difference is from the puts having a higher vol. The balance is from Dividends. Downside puts are skewed higher because stocks typically go down faster than they go up. Stocks tend to gap down vs "move" higher. In comparison, many commodities have the reverse skew. OTM calls are higher than OTM puts, because commodities when there are shortages tend to gap up, but "move" down during times of over supply.

1245

StockApprentice · Nov 2, 2012

It is volatility skew. It's something that was not priced into options before the crash of 1987. After that fun fiasco skew became the norm.

1245 · Nov 2, 2012

Quote from StockApprentice:

It is volatility skew. It's something that was not priced into options before the crash of 1987. After that fun fiasco skew became the norm.

I don't believe that's true. I was an options MM before and after the '87 crash. Customers basically never sold puts to open. They were only buyers so Puts were always high. Many times higher than put/call parity because few understood it and there was no electronic trading to take advantage of it.

Again, most of the disparity in price is because SPY pays a dividend. The dividend has the effect of pricing the underlying like it is lower by that amount. Skew of course is also adding to that.