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 The Call Spread : Skew Effect
Issued on August 19 2010 par Strategies-options.com
The presence of Volatility Skew modifies first of all the price of a call spread.
We had seen the perspectives of gains and risk linked with the call spread.
A limited gain/ a limited loss: here is why makes it a simple and attractive strategy. If we remind the graphic representation call spread on 1 year 100/120, volatility set at 30 % interest rate 5 % no dividend:  I - Every market exhibits a skew / smile Even if the pricing such as Black and Scholes or Cox Ross Rubinstein keeps in principle that volatility is constant, markets don’t think so.. There are very often different volatilities between terms and strikes which provide the study of the skew / smile in 3 D. II - Impact of the skew on the price of a call spread Starting with the call spread be bought, the point of view of the seller is a symmetry. In A positive skew A positive Volatility Skew implies volatilities increase with respect to the strike.The highest the strikes the highest the volatilities. Some commodities option markets react like that. Demand for calls exceeds that of equidistant puts with regard to the spot. Here is a  As far as we buy the lowest strike call we thus pay an implicit volatility less expensive than the one we sell. The call spread will be globally lower than of flat volatility. In A negative skew A negative skew implies volatilities decrease with respect to the strike.The highest the strikes the lowest the volatilities. Every Stock Index option markets react like that. Demand for put exceeds that of equidistant call with regard to the spot. Here is a put spread 100/120 (volatility 30% for the 100 strike,volatility 25% for the 120 strike )  As far as we buy the lowest strike call we thus pay an implicit volatility much more expensive than the one we sell. The call spread will be globally higher than of flat volatility. Next : Option Straddle : A First Attempt Previous : Long Call Spread : Delta Gamma Vega Download the pricer here BASIC OPTIONS STRATEGIES - INDEX BASIC OPTIONS STRATEGIES - CHAPTER I BASIC OPTIONS STRATEGIES - CHAPTER II BASIC OPTIONS STRATEGIES - CHAPTER III BASIC OPTIONS STRATEGIES - CHAPTER IV Strategies-options.com |
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