Skew Trading

No. Volatility trading is about absolute IV levels (high vs low). Skew trading is about RELATIVE IV across strikes. You can be neutral on absolute vol but have a skew view. They're related but distinct.

OTM puts are 'expensive' relative to ATM, not absolutely expensive vs fair value. You can't profit just by buying them unless you have a directional view (market crash) or skew view (puts will become even more expensive). The elevated IV is already priced in.

Yes. Singapore equity options (DBS, OCBC, UOB, STI) show typical equity skew - OTM puts have higher IV than ATM. The magnitude varies by stock and market conditions, but the pattern is consistent with global equity markets.

It can be very risky, especially short skew trades with naked puts. In a crash, short skew positions suffer significantly. Always understand the max loss (or potential loss for undefined risk) and size appropriately. Use defined risk structures when possible.

Depends on structure. Defined risk structures (butterflies, spreads) may require S$500-2,000 per position. Undefined risk (ratio spreads, risk reversals) require margin, potentially S$5,000-20,000 or more depending on strikes and underlying.

Calculate IV at different deltas (or strikes). Common approach: Find 25-delta put IV and 25-delta call IV (or ATM IV). Skew = 25d put IV - ATM IV (or - 25d call IV). Track this over time to understand normal range.

Skew steepens during fear (crashes, crises, pre-event). Skew flattens during calm (post-event, rally, complacency). Mean reversion tends to occur, but timing is uncertain. Catalyst analysis helps predict direction.

Calculate net position delta. Trade stock (or futures) to offset. For example, if position has +30 delta (per 1,000 shares), short 300 shares of stock. Re-hedge as delta changes. Consider stamp duty cost in Singapore (0.2% on buys).

Risk reversal: Very directional (delta of ~50), pure skew play, no premium for time value (both are short one, long one). Ratio spread: Less directional initially, can be set up for credit/debit, has extra short options. Risk reversal is purer skew but more directional; ratio has skew plus other risks.

Compare to historical. Calculate percentile rank of current skew vs past 1-2 years. Above 80th percentile = steep relative to history. Below 20th = flat. Also consider current market conditions - skew should be steep during stress.

Market makers track aggregate skew exposure across their book. They hedge by: (1) Offsetting skew positions, (2) Trading skew directly between underlyings, (3) Dynamic delta hedging as gamma creates directional exposure, (4) Using index vs single-stock skew for hedging. They set limits on total skew vega.

Index skew includes correlation: If correlation is high, index moves more like its components → index tail risk higher → index skew steeper. When correlation is low, index diversification reduces tail risk → flatter index skew. Differences between index and single-stock skew imply views on correlation.

Steps: (1) Define skew measurement (e.g., 25d put-ATM), (2) Calculate historical distribution, (3) Set entry thresholds (e.g., >90th percentile = sell skew), (4) Define structure (ratio spread, etc.), (5) Set sizing based on signal strength, (6) Define exit rules, (7) Backtest with realistic execution costs, (8) Out-of-sample validate, (9) Paper trade, (10) Go live with small size.

Just as we can trade skew levels, we can analyze how much skew moves around - its volatility. High skew volatility means skew is unpredictable; low skew volatility means skew is stable. This affects how you size and manage skew positions.

Variance swaps are replicated with a strip of options across all strikes, weighted by 1/K². Due to skew, OTM puts contribute more to variance swap replication cost. Variance swap price vs ATM vol difference reflects skew. Buying variance swap is long skew; buying ATM and hedging is short skew relative to variance.