RUT straddle: How do you play this?

[Joel Reymont]

Quote from optioncoach:

With indexes it is a little harder since the options are priced for large moves usually and the puts are skewed higher in price.

What does it mean that puts are skewed higher in price? I would think that calls are skewed higher in price since I paid more for the calls than the puts while the index price was just a tad ITM.

Also, why would puts be skewed higher?

Thanks, Joel

 

[El OchoCinco]

In most index options, the puts have a higher IV the further OTM you go. The main reason is that many institutions and funds buy OTM puts to hedge their portfolios. This buying demand pushes prices higher a bit and thus raises the implied volatility.

Also, market makers know that if the market starts crashing, people panic and purchase puts to hedge or profit from the move and this drives put prices higher. Since the market crashes quicker and harder than it rises, the puts are priced higher to account for this potential drop (market makers want to price in the risk).

The opposite happens to the call side as IVs decrease the further OTM you go.

So if you do a straddle on the index ATM you might not see to big of a difference but the IVs will be a little off between the two. Moreover, the IV you see might be calculated by the broker on the last trade, the average of the bid/ask or just one of them so the figures will always be slightly different (i.e. comparing 480 v. $490 strike in GOOG).

Quote from Joel Reymont:

What does it mean that puts are skewed higher in price? I would think that calls are skewed higher in price since I paid more for the calls than the puts while the index price was just a tad ITM.

Also, why would puts be skewed higher?

Thanks, Joel