In the recent Market Measures segment entitled “Should We Watch Skew?” Tom talked through the historical results of selling 30 delta puts in the S&P 500 ETF (SPY) when the SKEW Index was high. This was done in order to attempt to take advantage of the increased perceived fear in the market when SKEW is high. The results showed that this strategy was profitable in the past.
Today, we take a look at some of the traits that out-the-money puts tend to display when SKEW is high. First, historical periods that exhibited high SKEW witnessed increased prices for out-the-money puts on the S&P 500. This is because the SKEW Index rises as a direct result of traders perceiving added fear in the market; traders then buy up out-the-money puts to combat what they see as an increased probability of an outlier move.
As a result of far out-the-money puts seeing increased demand, the 1 standard deviation (16 delta) and 2 standard deviation (2.5 delta) puts move further away from the underlying’s current price. We tested and confirmed this by measuring how far these puts were from the underlying’s price in times of normal SKEW and compared that to times of high SKEW.
Finally, Tom talks through the historical profit and loss data that showed selling the 1 or 2 standard deviation puts in high SKEW environments was a profitable strategy. These results also lend to the idea that measures like SKEW and VIX are not great at predicting outlier risk or greater volatility, and that is why we sell options when these measures are high.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.