One thing I don’t understand about skew:

[VolSkewTrader]

You can do all the research and analysis you want to try and figure out why a particular condition or phenomena exists, but to truly believe in it you have to experience it. Like Wheezooo points out, when the market is rallying and you see that all you can do is buy OTM calls and sell OTM puts, then it only confirms your hypothesis about why that is.

I'd sometimes ask myself, "Why are these calls so easy to buy? Their IVs are so low to begin with, yet paper keeps selling them to me." Or maybe during a panic break I'd wonder why I couldn't buy a put to save my life.

Market-makers set the IV curves and vol surface. "Paper" or big institutional players with retail money are IV-ignorant and more concerned with nominal price. It's clear as night-and-day that they are the main buyers of OTM puts for downside protection, and the main sellers of OTM calls for put finance and income against their portfolio longs. Wheezooo, myself and anyone else providing counter-party risk to these large orders have to adjust our skews and curves to reflect the disparate demand between the downside and upside strikes. No quant research needed to justify the skew.

 

[Sig]

You can do all the research and analysis you want to try and figure out why a particular condition or phenomena exists, but to truly believe in it you have to experience it. Like Wheezooo points out, when the market is rallying and you see that all you can do is buy OTM calls and sell OTM puts, then it only confirms your hypothesis about why that is.

I'd sometimes ask myself, "Why are these calls so easy to buy? Their IVs are so low to begin with, yet paper keeps selling them to me." Or maybe during a panic break I'd wonder why I couldn't buy a put to save my life.

Market-makers set the IV curves and vol surface. "Paper" or big institutional players with retail money are IV-ignorant and more concerned with nominal price. It's clear as night-and-day that they are the main buyers of OTM puts for downside protection, and the main sellers of OTM calls for put finance and income against their portfolio longs. Wheezooo, myself and anyone else providing counter-party risk to these large orders have to adjust our skews and curves to reflect the disparate demand between the downside and upside strikes. No quant research needed to justify the skew.

Understanding why something is happening is never a bad thing and certainly testing out a hypothesis against data isn't "justifying". It is a level of professionalism that most traders don't rise to, but based on the level of discussion on this thread I thought it was a possibility here, my bad.

 

[VolSkewTrader]

I like the intuition behind this but curious if you have seen any quantitative support of the idea? If so would love to read up on it.

My guess is that the effect that covered call selling has on OTM call IVs would be nearly impossible to quantify. You would have to categorize every trade that takes place, requiring market participants to give an honest answer why a particular trade was executed...which would be ludicrous. Transparency no longer exists in the anonymous world of electronic trading. I used to have a very good idea what inventory retail customers had on, when and what market conditions they would initiate and exit positions, and even know exactly why they were executing a particular trade. Back then I could empirically quantify the effect their trades had on my IV curves and skews, because they were regular predictable market participants. Today, that is nearly impossible. Maybe the OTC guys would have a better idea.

 

[Wheezooo]

"It is a level of professionalism that most traders don't rise to, but based on the level of discussion on this thread I thought it was a possibility here, my bad."

Being someone who loves making childish comments, I have to compliment you. This one is right up there. Think of it as managing a large group and having to dedicate resources to different projects. I always had 400 things I was a week behind on, why dedicate resources to understanding something that will provide zero dollar benefit, and as VST correctly states, and you willingly ignore, how the f'k do you quantify it? I am sorry you confuse professionalism with needlessly wasting time and resources. Maybe you have never had that responsibility professionally?

"Understanding why something is happening is never a bad thing" - It was always peculiar to me how much better I traded products I knew nothing about. The moment I heard myself discussing the underlying fundamentals of any product I traded I knew I needed to slap myself across the face and wake up before I got myself in trouble.

 

[Philo Judeaus]

I'd sometimes ask myself, "Why are these calls so easy to buy? Their IVs are so low to begin with, yet paper keeps selling them to me." Or maybe during a panic break I'd wonder why I couldn't buy a put to save my life.

Could you please elaborate on this? What do you mean by, "IV's are so low to begin with, yet paper keeps selling them to me."?

 

[Wheezooo]

Could you please elaborate on this? What do you mean by, "IV's are so low to begin with, yet paper keeps selling them to me."?

So low means he is shaking his head with how low they are 'relative' historically, or maybe even realtive to actual price movement. It's also a 99% chance he owns them and feels himself choking on them, all while there is someone offering all you want in your face. This is almost always a function of everyone around you also owning them. This was the info benefit of standing in a pit. When someone quotes a strike and every market maker starts looking around the other way as though they were deaf. Tells you all you need to know. It is also why I have warned previously about never wanting the same position on as the weak hand market makers. Options may be about math, but there is a reason quants make sucky traders.

Same with when price is all over the place and vol won't go up, or when a product doesn't move for days or weeks but vol keeps going higher.

Funny, how I haven't had any of this happen to me for over a decade, yet the memories it brings back, writing it, irritates the hell out of me.

 

[Sig]

"It is a level of professionalism that most traders don't rise to, but based on the level of discussion on this thread I thought it was a possibility here, my bad."

Being someone who loves making childish comments, I have to compliment you. This one is right up there. Think of it as managing a large group and having to dedicate resources to different projects. I always had 400 things I was a week behind on, why dedicate resources to understanding something that will provide zero dollar benefit, and as VST correctly states, and you willingly ignore, how the f'k do you quantify it? I am sorry you confuse professionalism with needlessly wasting time and resources. Maybe you have never had that responsibility professionally?

"Understanding why something is happening is never a bad thing" - It was always peculiar to me how much better I traded products I knew nothing about. The moment I heard myself discussing the underlying fundamentals of any product I traded I knew I needed to slap myself across the face and wake up before I got myself in trouble.

When someone asserting that understanding is bad calls me "childish" I'll take that as a positive!

 

[Wheezooo]

1- Only you don't understand why. Everyone else accepts why. You just demand empirical proof.

2- I think four people agreed it is not really beneficial to define the one to ten reasons why and isolate each ones effect. Nor is it possible. You also speak about professionalism, but refuse to make an argument for why resources should be dedicated to this endeavor or suggest a methodology to do so.

3- When I say "anecdotally... consistent with what I have seen," it is referencing a database that is extremely deep, and one I trust entirely.

 

[VolSkewTrader]

Could you please elaborate on this? What do you mean by, "IV's are so low to begin with, yet paper keeps selling them to me."?

Wheezooo explained it perfectly, and it's a sinking feeling you would never want to experience. Initially you felt great if you were the first one on a "ticket" (first trader to get allocated a trade), but then you realize the broker has 10,000 more to sell to the crowd, and now your trade is an instant loser. When that happens you wish you were the very last guy on the last ticket of that 10,000 lot order, which is the only chance of that order being a winning trade.

 

[VolSkewTrader]

So low means he is shaking his head with how low they are 'relative' historically, or maybe even realtive to actual price movement. It's also a 99% chance he owns them and feels himself choking on them, all while there is someone offering all you want in your face. This is almost always a function of everyone around you also owning them. This was the info benefit of standing in a pit. When someone quotes a strike and every market maker starts looking around the other way as though they were deaf. Tells you all you need to know. It is also why I have warned previously about never wanting the same position on as the weak hand market makers. Options may be about math, but there is a reason quants make sucky traders.

Same with when price is all over the place and vol won't go up, or when a product doesn't move for days or weeks but vol keeps going higher.

Funny, how I haven't had any of this happen to me for over a decade, yet the memories it brings back, writing it, irritates the hell out of me.

I have to laugh because I have those same awful memories...hardly remember my really good trades, only the really bad ones. And I couldn't stand the other traders who would insist on trying to sell you more where you just bought them. But looking back I should have doing the same thing as them.

"Options may be about math, but there is a reason quants make sucky traders."

I trained under a guy who was a physics/econ double major from U. of Chicago. He was also a member of the Mensa club. He used to wear his Mensa club tie on the floor everyday. Bragged about how much smarter he was than everyone, condescending as all hell. Really knew his options theory, and he could recite the Black-Scholes equation at the top of his head. And guess what? He was the worst trader I've ever seen. He over-analyzed every little trade he did to death, suffered from chronic analysis paralysis. After every trade he would step outside the pit, his hands shaking and his brow dripping with sweat, and try and come up with every possible scenario how he might lose money. Then he would run back in the pit and immediately try to get out of it. It was both comical and sad to watch. He didn't last 6 months in the business.