Volatility Surface

Singapore has limited strikes and monthly-only expirations, making full surface trading challenging. However, you can still trade simpler surface concepts: skew at 2-3 strikes and term structure between front and back months. Focus on the most liquid points.

Compare IV at 25-delta put to 25-delta call (or ATM). Record this difference daily. Over time, you'll see the typical range. When the difference is unusually high or low, you've identified a skew distortion.

Demand for downside protection. Investors and institutions buy puts to hedge portfolios. This demand elevates put prices and IV. Also, markets tend to crash down faster than rally up, so puts need to price this risk.

Trading IV is betting on absolute IV level (will IV rise or fall?). Trading the surface is betting on relative IV (will put IV fall relative to call IV? Will near-term IV fall relative to far-term?). Surface trades can profit even if overall IV is unchanged.

At minimum: IV at ATM for 2+ expirations, and IV at 25-delta put and call for front month. Ideally: IV across all liquid strikes and expirations. You can get this from your broker's option chain.

Use a delta-hedged risk reversal. Trade the risk reversal (long call, short put or vice versa), then hedge the delta with the underlying stock. This isolates skew exposure while neutralizing spot movement.

Skew typically steepens during selloffs (fear rises, put demand increases) and flattens during rallies (complacency, covered call selling). Extreme skew levels tend to mean-revert. Use percentiles to gauge extremes.

Calendars are short front month (which decays faster) and long back month. In backwardation, front IV is elevated. If backwardation normalizes (front crushes more than back), the calendar profits. The calendar essentially trades the term structure slope.

Skew vega measures sensitivity to skew changes. Approximate it by shifting skew (e.g., raise put IV by 1 point, lower call IV by 1 point) and measuring position P&L change. This shows your exposure to skew moves.

Use structures like diagonals or double diagonals that have exposure to both. Or trade skew within one expiration (term-neutral) and separately trade term structure at ATM (skew-neutral). Document all exposures.

Collect IV at all liquid strikes and expirations. Use a parametric model like SVI to fit the skew for each expiration. Then interpolate across expirations. The residuals (market IV - model IV) identify potential mispricings.

Vega bucketing decomposes vega into components: parallel (overall IV shift), skew (skew changes), term (term structure changes), and time buckets (vega by expiration). This allows precise management of each exposure rather than treating vega as monolithic.

True dispersion requires liquid options on index and components. Singapore's limited options make this difficult. You could theoretically trade DBS/OCBC/UOB vs STI, but these are highly correlated. It's more of a conceptual framework than practical opportunity.

Arbitrage can arise from: butterfly prices going negative, calendar prices inverting, or call/put spread prices violating no-arbitrage bounds. In practice, bid-ask spreads usually eliminate these. Institutional traders with low transaction costs capture them.

Calculate P&L contribution from: (1) spot move × delta, (2) parallel IV shift × parallel vega, (3) skew change × skew vega, (4) term change × term vega, (5) time × theta. The sum should approximately equal total P&L. This reveals which exposures drove returns.