Skew is one of my favorite things. I’m not sure why, but I think the whole idea of it is absolutely incredible. The overall market skew is measured by the CBOE Skew index, but for our purposes, we like to examine the skew of the different financial securities.
Applying skew to the market as a bullish, buy-and-hold investor, skew actually isn’t so “great”. Individual stock indices have a downside skew, which means they are more likely to make a negative move than a positive one. That being said, the entire market has a positive upward drift, which means it is more likely to go up over time.
HOWEVER, we have to remember that we don’t have to trade JUST corporate stocks. We can also trade bonds, gold, and volatility itself, all of which have an upside skew.
But, as active traders, we know that it doesn’t really matter what way the market goes. We can place bullish AND bearish trades, profiting off any market environment.
With that in mind, we might look at golds, bonds, and volatility, and place long-term bullish trades in them. We can then turn around and place long-term bearish trades in stock indices. OR, we take advantage of the pricing array that skew offers, and place trades that take advantage of the cheaper side.
The cheaper side?
The skew of these instruments are all measured by the option pricing. If calls are more expensive than puts, we say that there is an upward skew. Vice versa, when puts are more expensive than calls, we have a downward skew. So basically, skew tells us what side of the options are cheaper.
We can take advantage of the relatively cheap call spreads in equities. For example, in my most recent article, I wrote about dynamic iron condors- taking double contracts on the call side and one contract on the put side to increase our profits without increasing our buying power.
In that same mindset, we can move into Gold or the other instruments with upside skew, and place more put contracts, without increasing the capital that we put up. In fact, we actually get more credit, and reduce our risk.
Overall, it’s just about getting the most bang for your buck. It’s good to know that stocks drift downward, but that’s over a looooong period of time. And we want to make trades that we can get in and out of in under 45 days.
So instead of placing directional trades based on skew, take advantage of the options pricing knowledge that skew offers. Place an extra put spread in a Gold iron condor, and reap those rewards. (By the way, we can play with bonds through TLT, and IV is traded under the VIX) Take that double iron condor in SPY or any other equity and make some profits!
Skew is much more than the directional bias of the stock- it tells us how we can make extra money, for no additional risk!
Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.