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Wednesday, May 22nd 2019

Volatility Skew and Buckets

Volatility skew can be broken down to delta buckets. Slope and derivative can also help identify over or underpriced areas of the implied volatility surface.

Summary

Volatility skew can be analyzed by breaking it down into delta buckets, which can help identify over or undervalued areas of the implied volatility surface. Comparing parameters to history, related stocks, or ETFs can also provide insight into overpriced areas. ORATS breaks down each expiration into 21 volatility buckets from 100 delta to 0 delta every 5 deltas, which can be tracked using their Monies part of the Data API.

Generalizing the implied volatility skew into parameters is a good way to get an overall view of the surface. Comparing the parameters to history, to related stocks or to ETFs is a good way to see what part of the skew might be overpriced. For example, if the slope is steep and other stocks or ETFs are not, the put IV might be overpriced relative to calls.

To drill down to the specific areas on the implied volatility skew, the use of delta buckets to categorize implied volatility can be helpful. ORATS breaks down each expiration into 21 volatility buckets from 100 delta to 0 delta every 5 deltas.

Here's a picture of XLK from 5/22/19 delta bucktest of IVs:

We call this our Monies (short for money-ness) part of the Data API. Trial

Monies are available each trading day back to 2007.

Tracking areas of the volatility surface using delta buckets can help identify areas of over or undervalued parts of the skew.

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