Are you looking for an edge in your options trading? Do you want to understand market sentiment beyond just price action? Then you’ve come to the right place. In this post, we explore a powerful concept and tool—implied volatility skew—and show you how you can use it to gain deeper insights into the market using the Market Chameleon platform.
At its core, implied volatility skew measures the relative difference in the implied volatilities of options with different strike prices but the same expiration date. In simpler terms, it’s a way of gauging the market’s perception of risk and the demand for various types of options—specifically puts versus calls.
There are two main types of skew:
One challenge you face in options trading is that the "days to expiration" for options decrease over time, which can make it difficult to compare skew over different periods. Market Chameleon overcomes this by using a "30-day constant maturity option." This synthetic option is created with a weighted average of options around the 30-day mark, much like the VIX is calculated, providing a consistent benchmark to track how skew evolves over time—independent of time decay.
To standardize vertical skew even further, the tool compares the implied volatility of 25-delta call options with that of 25-delta put options. Here’s how you can interpret the results:
Implied volatility skew is not static; it fluctuates over time. The Market Chameleon tool provides you with a one-year historical chart of the skew, plotting the difference between the 25-delta put and call implied volatilities. To help you interpret this data, the tool overlays two key reference lines:
For example, during the webinar on SPY skew analysis, the presenter highlighted that the current skew was slightly above both the 20-day and 250-day moving averages. This suggested a mild increase in bearish sentiment without an extreme demand for downside protection, even when overall volatility was elevated.
Understanding the relationship between skew and at-the-money (ATM) implied volatility is also critical. The tool plots the 30-day ATM IV alongside the skew, allowing you to determine if periods of high or low overall volatility are accompanied by significant changes in the put-call dynamic. In the webinar, despite ATM IV being at the 69th percentile, the skew did not indicate an overwhelming demand for protection, which provided reassurance about the market’s balance.
Another insightful feature is the ability to compare the skew of different assets. For instance, by comparing the SPY ETF’s skew with that of the QQQ (Nasdaq 100 ETF), you can uncover divergences in market sentiment between sectors or market caps. The webinar presenter noted that the SPY’s skew was moving away a bit faster than QQQ’s—possibly due to higher trading volume in SPY—highlighting potential opportunities for strategic decision-making.
By incorporating Market Chameleon’s implied volatility skew analysis into your trading toolkit, you can gain a clearer picture of market sentiment. You’ll be able to:
While no tool can guarantee profits, understanding these dynamics empowers you to make more informed decisions. By leveraging this analysis, you become better equipped to evaluate risk and uncover opportunities that align with your trading strategy.
Ready to dive deeper? Explore the tool and start refining your options trading strategy today on the Market Chameleon platform.
Financial Disclosure:
This blog post is for informational and educational purposes only and should not be considered financial or investment advice. Trading options involves significant risk, and you should consult a financial professional before making any investment decisions. Market Chameleon provides data and tools to support your analysis but does not guarantee any specific outcomes.
By understanding implied volatility skew, you’re one step closer to decoding market sentiment and enhancing your trading decisions. Happy trading!