One thing I don’t understand about skew:

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ducatista

Recently started studying options and now reviewing distributions, kurtosis, skew, etc. I understand that certain market returns exhibit specific types of skew vs others. Eg commodities often have forward skew, index options have negative skew, etc.



But I’m finding alot of diverging information regarding individual stock skew. It seems longer term single name options are mostly negative skew, but short term I’m confused about. Some resources tell me theyre mostly normal (vol smile), others tell me mostly positively skewed, and still others say theyre mostly negatively skewed. Some say its variable (eg smaller firms are generally positively skewed, larger firms negative skewed). What am I not understanding here?



My own personal research (eg just searching firm by firm) leads me to think it just varies on a case by case basis. Most firm level IV smile graphs I look at tend to be smirks w negatively skew, with the occasional chart being more normally distributed like a smile. Can someone please help me understand?
 
Long-dated options show very very little skew - you need to make certain you are modeling them correctly. Most common models will give an output which is generally right about the price, but incorrect on the greeks. You would like to make certain you use a purpose-built long-dated model and tools get fairly pricey. Hit the net if you want to see some of the discussions and research. You'll see a lot of commentary about the Buffet put which is really more conversation than fact. The real issue in long-dated is the distribution becomes much more normal and interest rates play a larger role than the volatility.
 
I have found that the shorter the maturity (time to expiration), the more it's skew and overall IV behaves independently compared to the longer dated curves on the same term structure. The vegas are so small for these options that traders are often are more concerned with the individual tick values (actual price) and tick differences between strikes rather than the actual IVs. Because of their tiny vegas, a big buyer of short-term OTM calls can dramatically shift the skew in favor of the upside strikes vs the downside (OTM puts) in IV terms, causing the smile to look more symmetrical than the negative skew you're used to seeing.
 
Also, I think shorter-term skews reflect more what the gamma risk (movement behavior) of the underlying will be like if it were to go to a particular strike rather than the overall IV risk. Whereas the longer-term skews indicate what the market believes the ATM IV (vega risk) will be if it goes that part of the curve.
 
VolSkewTrader said:
Also, I think shorter-term skews reflect more what the gamma risk (movement behavior) of the underlying will be like if it were to go to a particular strike rather than the overall IV risk. Whereas the longer-term skews indicate what the market believes the ATM IV (vega risk) will be if it goes that part of the curve.
More...

Does this mean sticky strike is more applicable to "1 month options" and upwards, than "one week" options? ... or the other way around?
 
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Sticky strike vs sticky delta is more product-specific rather than maturity-specific. Also depends on the behavior of the underlying. Not entirely sure the degree of IV stickiness per strike depends on its DTE, something I would need to observe more closely.

I think the point I was trying to make is that overall IV and skew (the difference in OTM call IV vs OTM put IV) are of less importance in the front months than they are in the back months due to differences in vegas.

Very close to expiration I only look at the price, delta, gamma, and theta. The IV and vega I completely ignore.
 
I think I understand now. Apparently, I had it all wrong?

So short term maturities exhibit some skew usually. Index options always negative skew. Single names can be positively skewed, negatively skewed, or exhibit a smile/frown depending on what’s on the horizon/what big buyers are doing.

Longer term maturities tend towards normality (since long duration = more time to recover from some black swan event). Equities are more normally distributed, index options are less negatively skewed.

And to bolster via VST’s points, short term maturities are also more sensitive towards changes vs long term maturities. I saw a quora post theorizing that short term maturities are more skewed and longer maturities are less skewed because traders will pay more to be long Gamma in the near term and will Delta hedge by selling the long term Vega… or something like that.

Am I correct in my understanding of all this? Also, do long term commodities etc also tend towards normality?



https://www.quora.com/Why-is-equity...y-skew-more-pronounced-for-shorter-maturities
 
For the most part you got it. Not sure I agree with your statement of "Equities are more normally distributed, index options are less negatively skewed." Equities exhibit the same lognormal price distribution as Indexes do. And Index option curves are generally more negatively skewed than individual equity vol curves.

Also, what do you mean by "normality"? There is no such thing as a normal skew or curve shape if that's what you're getting at. Each asset class exhibits its own particular skew and IV behavior.
 
When I say normality, I mean a more Gaussian distribution. Eg less skewed

So in the first part, I meant that single returns are skewed in the short term, but their returns start to look more normal @ long term maturities. Less skew. And that for indexes, the negative skew that exists is more pronounced in the short term vs the long term maturities where it is less pronounced (although it still exists)

Re: the second point, I mean a more normal distribution curve. And that in the long term, the distributions tend to approach this (?)
 
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