Trading The Skew: The Risk Reversal - YouTube

hi welcome to another edition of options in  oswald and this is oswald hey oswald how you  

doing today oswald wants to talk today about  the reverse skew that options trading below  

spot are trading in more demand or high implied  volatility than options trading at the money  

we call that a reverse skew and equities  tend to trade in a reverse skew most of  

the time especially when markets become extremely  volatile the skew below strike can get extremely  

steep now the reason that is people tend to buy  out of the money puts to protect their portfolio  

the demand for out of the money puts dries up the  implied volatility or the price of those out of  

the money options so you could say that out of  the money puts become very expensive compared to  

out of the money calls so if we're looking at  moneyness and let's say i'm looking at a 10 out of  

the money put let's say 10 below spot and i look  at the price of a 10 percent out of the money call  

or above spot the price could be drastically  different and what that allows me to do  

is that allows me to actually sell very short  dated puts and then use that money to buy calls  

and i could buy calls actually closer to the money  for less than i could buy further out of the money  

puts one of my favorite trades in a very steep  skew reverse skew environment and what we were  

seeing of course through the covet crisis we were  in a very steep skew through early 2022 we're  

seeing a very steep uh reverse skew what we like  about that trade is positive delta positive gamma  

but it doesn't have a lot of carry cost in  other words the gamut to theta ratio is very  

favorable not only that it's not too  vega heavy and what that simply means is  

if the market should rip because we're selling  puts which is negative vega and we're buying  

calls which is positive vega the vega is usually  a lot lower than if i was just buying calls  

and that neutralizes my vega it also gives me nice  gamma good delta but i'm not paying a ton of data  

as i said gamma to theta ratio is very favorable  um are you not interested in this conversation  

mr oswald so anyway as you can see from this  illustration we can actually sell 10 puts and buy  

18 calls in a short term risk reversal or a  ratio risk reversal we're actually buying a  

lot more calls and we're selling a lot less  puts where that becomes exciting is you can  

reduce the number of puts and therefore even  if the market blows through your short put  

if you're notionally de-leveraged on the output  then your risk is only what you're emotionally  

exposed to take a look at our video on notional  exposure to explain what i'm talking about there  

but that's a real good way to trade the skew in  following videos i want to talk about other ways  

we can trade the skew other than a risk reversal  talking about if the skew is steep in reverse or  

we'll get into how about if the skew is a forward  skew like you tend to see in a lot of commodities  

what are the best structures to trade that stay  tuned for more of options in oswald as oswald here  

seems a bit indifferent about this particular  subject but uh we'll pick them up on the next  

one thank you for listening if you liked the  video if you think it was value-added give us  

a thumbs up and do subscribe to our channel  a lot more information to come thank you