Skew Trading

Skew trading can be capital-intensive due to margin requirements for ratio spreads and risk reversals. However, you can start with defined-risk structures like put spreads vs call spreads at the same delta, or paper trade to learn the dynamics. Start small and size for worst-case scenarios.

Skew does tend to mean-revert from extreme levels, but it can stay elevated or depressed for extended periods - weeks to months. Don't assume immediate reversion. Also, the 'mean' level itself shifts over time based on market structure and regime.

Many brokers provide basic IV by strike data for free. For more sophisticated analysis, platforms like thinkorswim show IV by strike, and tastytrade displays skew metrics. Professional tools like Bloomberg are helpful but not required to start.

Skew trading offers different opportunities: (1) Potential edge from relative mispricing, (2) Can profit even if stock doesn't move much, (3) Often collects premium from rich options. However, most skew trades DO have directional exposure, so they're often complementary to directional views.

If you have a pure skew position (e.g., risk reversal), an overall IV move affects both legs - but not equally if they have different vegas. You still have vega exposure. This is why understanding your net vega and potentially hedging it matters for pure skew bets.

Risk reversals have defined-ish risk on both sides and balanced exposure. Ratio spreads have unlimited risk on one side but can be structured to collect more premium from rich skew. Use risk reversals for balanced skew + direction; use ratio spreads when you have strong conviction the extra short options won't be challenged.

Not necessarily. If you're comfortable with the directional exposure and it aligns with your market view, let it ride. Delta-hedging adds costs and complexity. However, for larger positions or when you want purer skew exposure, hedging is worthwhile. It's a judgment call based on size and thesis.

Earnings typically causes post-event IV crush and skew flattening. If you're long skew (expecting steepening), earnings might hurt. If you're short skew (expecting flattening), earnings might help. Consider your position relative to earnings timing and adjust or exit if needed.

VIX and SPX skew are positively correlated but not perfectly. High VIX usually means steep skew (fear on all fronts). However, they can diverge - skew can steepen without VIX moving if there's specific concern about tail risk. Monitor both for a complete picture.

Common approaches: (1) Fixed threshold - rebalance when delta moves by X (e.g., 0.10 or 0.20), (2) Fixed time - daily or weekly, (3) Percentage of position - when delta PnL exceeds X% of position value. More frequent = more costs but tighter control. Start with daily or threshold-based for most positions.

Index vs single-stock skew dispersion: (1) Sell index skew (short index OTM puts, long index OTM calls), (2) Buy weighted single-stock skew (long component OTM puts, short component OTM calls). Bet: Index skew is too steep relative to components. Requires many positions, careful weighting, and constant monitoring.

Dealers often accumulate negative gamma and long skew from customer flow (selling puts, buying calls). Their hedging creates market impact. When dealer positioning is extreme, reversion pressure builds. Track dealer gamma exposure (GEX) for signals about potential skew normalization.

Vanna measures delta sensitivity to IV changes. Skew positions often have significant vanna - as IV moves, your delta shifts. This creates unintended directional exposure if unmanaged. For large positions, monitor vanna and adjust delta hedges as IV moves. Vanna can also be a profit source if managed actively.

Persistent steep skew: continuous institutional hedging demand, structural put buying programs, recent crash memories. Persistent flat skew: extended low vol, widespread covered call selling, complacency. Regimes persist until the dominant flow changes or a catalyst forces adjustment.

Plot skew (e.g., 25d put - 25d call) at each expiration. Near-term often steeper (immediate concerns). Long-term flatter (time averaging). Anomalies (e.g., far-term steeper than near) indicate unusual expectations. Trade calendar skew by going long in flat terms, short in steep terms, betting on convergence.