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Minyan Mailbag - Option Smiles

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Hello John,

As you watch closely volumes on put/calls as a sentiment indicator, did you notice the magnitude of the smile on SPX and NDX. While calls out of the money are worthless (implied vol of 15 for June 2005 1995 call), low delta put implied volatility are around 31%. While this smile exists since the 1987 crash, it has never been that magnitude in relative (NDX smile / atm ndx implied vol). Explanations may be various, but I think the best one is that structured products, covered calls hedge funds are selling massive amounts of low delta calls while bidding low delta put. In case markets would rally, that could put a big squeeze on these traders.

I would be very interested if you had a look.

Regards,
Minyan Julien

Julien,

We don't agree with this assessment.

The "smile" or skew for SPX rolling three month strikes 20% over the strike versus 20% under the strike (probably the widest percent skew that is still relevant) has been stable for the last year around 6 volatility points. It reached a high of 8 points early in the second quarter and is now 6. For the rolling one year implies they have been between 8 and 10 volatility points and are now around 8.5 points.

For the NDX the range for the rolling three month same skew is stable around 6 points and the rolling one year stable around 9 points.

The actual level of at the money SPX volatility for nine months options is around 15% and for the NDX around 23%.

In English this simply means that the skew is not wide and the overall level of volatility is relatively low. Both show moderate complacency.

Regards,
Prof. Succo

No positions in stocks mentioned.

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