SPX OTM calls IV crush

[Same Lazy Element]

Using ratios like 50/25 IS normalization. Ratio-ing different delta points of the vol curve to the ATM or 50 delta point is industry standard.

I misread his explanation, I thought he was looking at the vol difference. The skew has flattened, no question about it. But no, it's not an industry standard, SK10 is what people usually talk about when people discuss the skew.

 

[Same Lazy Element]

You would have been long gamma starting out. The 2 lower IV OTM 25 delta calls are more gamma rich than the higher IV ATM. That's called skew theta. On the way down you probably would have been slightly long to flat gamma. And you would have been long vega the whole way down. Further OTM calls have more volga/vomma (vega convexity) than ATMs (which have zero vomma). That's a homerun trade that would have landed you at the Ferrari dealership.

Dude, I know that that gamma would be long at inception (oh, and you probably would be bleeding a little bit at those levels). Depending on the expiration, you gamma would be really long to flattish and yes, you would be long vega. You gamma path is going to depend on the expiration.

What expiration would you do it? Your path would strongly depend on the expiration (vega or gamma dominating) - Dec 3375/3650 1x2 (back of the envelope) would be a very different trade from Apr 3375/3475 1x2. I am too lazy to calculate anything, but I recon you'd make money in Dec and lose a ton in Apr.

PS. on the second thought, you're right - it would have been a great trade, esp in longer maturities; in fact, it would probably make money if we continued to rally, since 25ish delta was probably like 11 vol and would probably re-strike. A losing scenario would have been a low realization where you did not profit from your gamma or a low-grade selloff that would have actually steepened the skew.

 

[VolSkewTrader]

I misread his explanation, I thought he was looking at the vol difference. The skew has flattened, no question about it. But no, it's not an industry standard, SK10 is what people usually talk about when they discuss the skew.

SK10 is mainly for equity or index traders, although I've used it for other fixed skew products. I've never heard a Eurodollar, Treasury, or commodities trader ever mention SK10 as a skew measurement. Normalized Skew (25d put - 25d call/50d) is widely used across all asset classes and often quoted in F/X. I know lots of traders who look at different delta point ratios to the ATM/50d point. And I know some prop groups who only look at standardized moneyness points on the curve and vol surface. So everyone has their preference, and not eveyone trades equity options.

I believe SK10 only looks at the time-adjusted downside (put) 90% moneyness point, and excludes the upside (call) picture for skew. So its only good for put dominated instruments like equitiies.

 

[Same Lazy Element]

SK10 is mainly for equity or index traders, although I've used it for other fixed skew products. I've never heard a Eurodollar, Treasury, or commodities trader ever mention SK10 as a skew measurement. Normalized Skew (25d put - 25d call/50d) is widely used across all asset classes and often quoted in F/X. I know lots of traders who look at different delta point ratios to the ATM/50d point. And I know some prop groups who only look at standardized moneyness points on the curve and vol surface. So everyone has their preference, and not eveyone trades equity options.

I believe SK10 only looks at the time-adjusted downside (put) 90% moneyness point, and excludes the upside (call) picture for skew. So its only good for put dominated instruments like equitiies.

Yeah, it's the equity derivs standard and it's a picture of linear skew. Makes it easy to approximate stuff like var swaps and makes an easy comparison between indices or stocks. In rates (I started as a IR swaptions market maker back when rates used to actually move) it was something like +/-25bp collar that was the most quoted and referenced (so very similar to sk10). This said, I have not gotten involved in anything other than equity index (pretty much a single index, too) for the last 15 years.

I believe my previous instance (@sle) had a post explaining the advantages and disadvantages of the different skew representations, lol.

 

[gowthamn]

SK10 is mainly for equity or index traders, although I've used it for other fixed skew products. I've never heard a Eurodollar, Treasury, or commodities trader ever mention SK10 as a skew measurement. Normalized Skew (25d put - 25d call/50d) is widely used across all asset classes and often quoted in F/X. I know lots of traders who look at different delta point ratios to the ATM/50d point. And I know some prop groups who only look at standardized moneyness points on the curve and vol surface. So everyone has their preference, and not eveyone trades equity options.

I believe SK10 only looks at the time-adjusted downside (put) 90% moneyness point, and excludes the upside (call) picture for skew. So its only good for put dominated instruments like equitiies.

Yes, the skew changed. What should happen if it has to get back to the way it was last week?

 

[VolSkewTrader]

Yes, the skew changed. What should happen if it has to get back to the way it was last week?

The IV of those OTM calls are going to continue to underperform if the market continues to creep up. A violent reversal at 2850 or 2900 and a sustained move back toward 2600 should pump those call IVs back up. Problem is the Fed has killed the vol for this product. Fed's making it impossible to short anything with their unlimited bids in IG and HY corporates.

 

[gowthamn]

The IV of those OTM calls are going to continue to underperform if the market continues to creep up. A violent reversal at 2850 or 2900 and a sustained move back toward 2600 should pump those call IVs back up. Problem is the Fed has killed the vol for this product. Fed's making it impossible to short anything with their unlimited bids in IG and HY corporates.

Yes the IV was good enough last Thursday and Friday. This week is fell a lot relative to 50 Delta.

I have also seen the OTM maintain good IV if the market aggressively goes up too. But if the market is just trading sideways, the OTM falls

Could this be happening because of FED meeting today?

 

[taowave]

Yes indeed...
I will have to check,but when the meltdown took place,I got in to the May 2800/3300 1 x 4 call spread for even money. did a similar trade in AAPL..I do not hedge these type of spreads,knowing full well that the Vol(wings) will get crushed on a bounce while the skew reverts.I was up 15% for the month,which is a fraction of what I could have made if I left the country and came back today..

I am awful at milking trades

Did you play that at all this time around? Mid-march you had Dec 3000/3400 strikes trade less than a vol apart.

 

[taowave]

Off the top of my head,I dont believe you make any "real money" trading the ATM/25 D 1x2 backspread in a crash. Yeah,the OTM strikes picked up more than the rest of the smile,but they lost vega as the market cratered,while the pre crater 25D put blew up,had real vega plus your gamma kicked in..Thats the home run..

Think about it,in a crash would you rather be short futures,long 25 delta calls,or long futures 25 delta puts??

Yeah the smile went your way, its nice on a graph,but those little 25D pre crash calls are simply overpriced wings at that point that have picked up 10-15 vol handles but not much in absolute dollars.Its the pre crash 25D puts that buy you the Ferrrari..

As you can see,I dont love 1 x 2 ATM/.25D call backspreads in the SPX

So this clearly shows that the OTM 25 delta call IVs blew up much more than the rest of the smile when we crashed in March...albeit they probably started at incredibly depressed IV levels vs the ATM when were close to the market top in mid Feb. When we crashed last month the SPX curve flattened dramatically. OTM Call IVs far outperformed same delta OTM Put IVs, which most traders don't realize.

So buying single-digit IV OTM calls and hedging them before a crash is as good or better than buying the steeper IV OTM puts. Only problem is that on the crash you move so far away from your long OTM calls that their vegas are too small for you to really hit the homerun....most of the money is made on the gamma.

Selling 1X 2s (sell 1 ATM vs buy 2 25 delta calls) would have been the way to go when the SPX peaked in mid-Feb. On the way down, your 1 x 2 would have killed it as the OTM IV call skew exploded vs the rest of the curve. Obviously on the way up you want to have the opposite.

Now, the IVs of those OTM SPX calls are imploding because no one wants to own the upside strikes where the SPX is probably going, which will be the worst strikes to own when the VIX crashes back below 20.

You would have been long gamma starting out. The 2 lower IV OTM 25 delta calls are more gamma rich than the higher IV ATM. That's called skew theta. On the way down you probably would have been slightly long to flat gamma. And you would have been long vega the whole way down. Further OTM calls have more volga/vomma (vega convexity) than ATMs (which have zero vomma). That's a homerun trade that would have landed you at the Ferrari dealership.

 

[Atikon]

Although you would have gotten killed selling hedged OTM calls on the way down trying to pick the top in vol/market bottom back in March. I probably would have sold some when VIX hit 50, then more at 60, stopped out at 70, then reloaded at the 80 VIX level and prayed that VIX wouldn't go to 100. I would have had to underhedge the call sales to have made any money. Easier said than done.

you basically daytraded with calls during that time, closed WYNN 3x a day with calls