Volatility and Skew

As we have mentioned before, volatility consists of a statistical number that does the job of measuring the amount of movements that a security has over a certain period of time in the past and also how much it is expected to move in the future. In cases in which a stock has had very big movements in the past, and when it is expected to continue moving, it causes the volatility figure to inflate; and when this occurs it increases the price of the option. In cases in which a stock has remained quiet and is expected to remain as such, the figure of volatility will be reduced, and this as a result decreases the effect on the price of the option. The higher a volatility figure, the higher the option price will be as a result. Whenever the market sells off in general, it causes the volatility of the options to go up because of the fear factor of the downside moves. This causes people to begin paying more elevated prices to have downside safety and this then inflates the option prices that then heats up the indirect volatility numbers. There are cases in which when one looks at the numbers in a chart in which you will notice there are number that start to get higher as you move down in strikes and this is known as reverse skew. So how is skew supposed to be good and assist a person in their options? Skew is able to help a person when they are carrying out option spreads. There are a couple different reasons for this. First of all it is good to create a hedge for a first option trade with an opposing option position. This will take care of maintaining the starting off cost low and will give you the option of taking part in more trades. Then, doing this also allows you to very likely make up for an option buy with a sale of an option at a more elevated implied volatility level. These spreads can either be straight debit, ratio spreads, or straight up credit. When one buys an option at a lower volatility level and then sells another option that has a higher level of volatility, it means you are getting the volatility edge on the trades you have. While it is true that buying the spread will be more expensive, the total outlay will be less than what it could be.

Beginner Money Investing Volatility of Options Historical Volatility - HV & Implied volatility - IV How to make volatility work for you Different Volatility on Different Stocks Volatility and Skew