Volatility skew in volatile markets

[Aber]

In a volatile market with uncertainty it's more likely that we see a volatility skew and not so much a smile. Therefore it must hold that, in chaotic markets, out-of-the-money calls and in-the-money puts are in greater demand than in-the-money calls and out-of-the-money puts.(am I correct?)

But how come OTM calls and ITM puts are more in demand in volatile markets?

Eg. the day after Brexit there is a skew for USDGDP options

 

[financeguy]

In a volatile market with uncertainty it's more likely that we see a volatility skew and not so much a smile. Therefore it must hold that, in chaotic markets, out-of-the-money calls and in-the-money puts are in greater demand than in-the-money calls and out-of-the-money puts.(am I correct?)

But how come OTM calls and ITM puts are more in demand in volatile markets?

Eg. the day after Brexit there is a skew for USDGDP options

I don't follow the logic?

 

[Archidamus]

Options skew is usually referring to the prices of the options and how symmetrical they are. As for equities they have a left skew as the options for a 10% OTM put is greater than a 10% OTM call. Logic being that 10% down moves are more likely than a 10% up move.

As for commodities they exhibit a right skew, since crude oil would more likely jump 10% during a crisis versus a 10% down move.

Check out the S&P 500 versus to SKEW index, a SKEW index of 100 means that puts and calls are symmetrically priced. A SKEW above 100 means that puts are more expensive than calls that are the same distance from the current trading price. The SKEW is usually high when the market is making new highs, as people are afraid that the market has 'topped out' and there might be a big down swing coming.

As for a FX product, the riskier side will probably exhibit the skew. Assume you are trading the US dollar versus the Venezuela Bolivar. You'd assume that the most likely 'big' move would be a devaluation of the Bolivar. Thus the options in the direction of a declining bolivar would be more expensive than options on the opposite side.

 

[rajanS]

In a volatile market with uncertainty it's more likely that we see a volatility skew and not so much a smile. Therefore it must hold that, in chaotic markets, out-of-the-money calls and in-the-money puts are in greater demand than in-the-money calls and out-of-the-money puts.(am I correct?)

But how come OTM calls and ITM puts are more in demand in volatile markets?

Eg. the day after Brexit there is a skew for USDGDP options

Out of money calls are more expensive because if stock price does fall, the gamma of the position becomes riskier. Hence more frequently the market maker has to hedge his otm call opions, hence higher the price. The arguments for why ITM puts are more expensive...follows similar line of logic