Wednesday, January 04, 2006


Marketz : What about the Skews ?

Yesterday, I analyzed the technicals on the QQQQs and the SMH in these two posts, one on chart levels and the other on volatility skews.

Lets review to see if I had anything useful to say.

"Both the QQQQs and the SMH are sitting right at their 61.8% Fibonacci Retracement Levels. SMH is also at its 50 DMA. I dont expect the 34.43-34.61 gap on the SMH to be filled anytime soon-that is a remote possibility at this point. In the near term, I see one of two scenarios unfolding :

Scenario 1 : Bounce from these levels, implied volatility (VXN right at 50 DMA) slips and the uptrend that started in late Oct is intact.

Scenario 2 : RSI is not yet in oversold territory on either chart, so a further retracement to a lower level is possible. If the retracement is to the 50 % level, implied volatility will remain static or increase (but not spike). If the retracement occurs to the lower 39.2 % level, QQQQ gap (39.46-39.68) will be filled and expect implied voltaility to spike as fear sets in among sellers of the 35 puts on the SMH and 39 strike on the QQQQs.

Finally, note that the 50 day and 200 day moving averages for both ETFs are still sloping upwards."

Turned out Scenario 1 panned out in technicolor. Of course, we'll need a little more time to see if the uptrend is still intact. But today's high volume blockbuster rally is certainly encouraging.

As for the voltaility skews,

"What we see now in the QQQQs (at 40.41 as of 12/30/2005) is that at equidistant strikes, the implied volatility of puts is uniformly larger than the IV of calls. In the event of there being no market bias, the skew is 1.0 since calls and puts at equidistant strikes cost the same. Now, the skew close to the spot price is between 0.9 and 0.95. The market is pricing in a small but significant bias that stock prices are headed lower.

Does that mean the market will go lower ? Not necessarily. Traders can fade this bias by buying the cheaper options(the calls) and selling the more expensive ones (the puts).

In the recent past, I have noticed that market biases on highly liquid ETFs seem to be faded while the market biases in individual high beta stocks seem validated. "

Traders faded the market bias alright, as they have been doing recently on the ETFs.

What does all this portend for tomorrow ?

I have not had the time to run the spreadsheet program. Nevertheless, lets take a quick look at the skew of calls vs puts. QQQQ is at 41.30 so the 41.63 and 41 strikes are nearly equidistant from the spot price.

ITM 41 call has IV of 14.9 while ITM 41.625 put has an IV of 14.3 Skew = 1.04.

OTM 41.625 call has IV of 14.8 while OTM 41 put has an IV of 14.3 Skew =1.03

Close to the spot price, the market is almost neutral, ie bias although in favor of calls is very small.

Lets dig a little deeper now, for ITM strikes [1.3] distant from spot price, Skew = 1.22 and for OTM strikes [1.3] distant, skew= 0.90

Again, ITM calls diverging in price from in the money puts, but nothing spectacular. Remember that the skews grow larger as you go deeper in the money. Little market bias- basically neutral.

Technorati Tags :

Comments: Post a Comment

<< Home
Disclaimer: This site may include market analysis. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

This page is powered by Blogger. Isn't yours?