In today’s Best Practices segment, Tom and Tony tackle a more advanced topic within the options universe – skew in options prices. Skew refers to where options are most expensive in a given market relative to that market’s underlying price. Markets can witness more expensive options to either the put side or call side depending on where supply and demand dictates the greatest fear of underlying movement lies.
Broad equity markets tend to show skew in their options to the put side, which is due to most of the fear in that market being to the downside. This occurs through traders buying puts more heavily than calls and thus driving up the prices of these options. The excessive demand in the market for puts drives up the implied volatility on those put options relative to their call counterparts. This is not the story for all markets. Markets like that of gold currently can show no skew, witnessing equal demand on both sides of the underlying price. Finally, some markets can show skew to the upside in their calls, such as the commodity markets of wheat and corn. Take a look at the segment above for further clarification concerning skew.
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