The second presentation at the CBOE Risk Management conference teams up Sheldon Natenberg with Stefan Wintner from SigmaSquare Capital. The followed up on the initial session on option pricing through discussing The Volatility Surface: Skew and Term-Structure.
Natenberg starts out noting four important questions with respect to volatility —
- Why does the implied volatility vary across expiration date and exercise price?
- How can we model the volatility term structure and skew?
- How do changes in the term structure and skew affect the risk of an option position?
- Are there trading strategies which focus on changes in the term structure and skew?
Among the highlights of his second presentation was the statement that most underlying contracts have a typical or average volatility to which they tend to revert over long periods of time. He also discusses a concept of forward volatility. Using a forward volatility curve allows traders to lean toward wanting to selling or buying different option contracts. The curve will depict which options may be undervalued and which are overvalued. A final highlight from his part of the presentation was his statement that a common measure of volatility skewing for options that share expiration dates is the difference between the implied volatility of a -25 delta put and 25 delta call.
Stefan started out his session asking how many attendees that have used VIX derivatives in their portfolio. A good number of attendees raised their hands. I found a statement that Stefan made particularly interesting was that three of the thirty biggest relative VIX price changes have happened in 2013. As a relative move he is looking at percentage change day over day. Stefan demonstrated the significant impact of skew upon price changes in VIX. He finished up by noting that the skew tends to be steep due to systemic concerns such as the end of QE, inflation concerns, etc.