When stocks rise Implied Volatility (IV) generally declines. There is an inverse correlation between stock prices and IV. IV Rank (IVR) will be lower too. This is because traders fear a huge down move much more than a huge up move. Another result of this fear is Volatility Skew. We normally see Puts priced higher than Calls with the same Delta even though the Put will be farther out-of-the-money (OTM). This situation does not hold true for many Futures and Futures options. Gold has seen a lot of activity lately. What is the correlation between Gold and its IV? What type of Volatility Skew is there in Gold?
A 6 month graph of GLD (Gold ETF) and Gold Volatility showed that they usually move together. They have a positive correlation (0.59). When Gold rises, Gold volatility rises. A table showed that over a 6 year period that Gold and IV had a positive correlation 35% of the time and a negative correlation 65% of the time. A table was displayed which showed that GLD (the Gold ETF) was currently trading with an inverse in which the 16 Delta Calls were more expensive and farther OTM than the 16 Delta Puts.
Our study was conducted in GLD (the Gold ETF) from 2011 to the present. We sold the 1 Standard Deviation Strangles (16 Delta Call & Put) and recorded the distance of the Call and Put from the price of the underlying to identify skew. We observed IV, IVR and 1 week price action preceding all occurrences. A table of the study results showed that Gold had inverse skew 60% of the time and normal skew 40% of the time. There was no meaningful pattern detected in the prior five trading days. Normal and inverse skew have both been seen in all implied volatility environments, from a rank of 0 to a rank of 100. Normal skew in GLD was generally observed after a down move in the underlying.
For more information on Volatility Skew see:
Market Measures from January 6th, 2015: “Visualizing | Volatility & Skew”
Best Practices from March 30th, 2015: “Volatility Skew”
Best Practices from May 23rd, 2016: “Volatility Skew”
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the key takeaways and the results of our study on GLD, its Implied Volatility, how often it displays a normal or an inverse Volatility Skew and how this can help our trading.
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