Upside Vol Skew in SPX is abnormally high

BY ANDREW GIOVINAZZI

January 23, 2024

Yo Pit Crazies,

Mark and I are running a can’t lose trade in Trading Desk and Daily Riff Trades are helping our Roomies print in this action packed market. Sign up now to get a spot.

The can’t lose trade in the Trading Desk is a can’t lose because I sold out SPDR S&P 500 Trust (Ticker: SPY) calls on the way up and that gives us half the trade for free with time all the way to Feb16 expiration. The trade is long VIX calls and long SPY calls. Why did we pick those two instruments? That is a long time to see which way the market is going and getting paid to wait.

One big reason is the FOMC comes out on rates on Jan31st. No one thinks they will cut but they could talk dovish. Over the last year that has sent stocks into orbit. In the Trading Desk, Mark and I identified the VIX curve as being “compressed”, prone to shocks but both up and down shocks in SPY/SPX/XSP.

Closing screenshot SPY Feb16 cycle

There is another trick for spotting abnormal vol skews in SPY.

You just need to know where to look.

I was an SPX trader 30 years ago

That seems like a lifetime ago and it was. It was the early 1990’s and the internet boom was only some dumb little stock called Netscape. They had a browser and no one knew what that was. Email accounts were high tech. What has not changed much is the range of calls and puts relative to the at-the-money (ATM) options in SPX. The fact that the implied volatility (IV) is different per strike is a direct slap in the face for the Black-Scholes Model (BSM) which is the granddaddy of modern finance. BSM just knows one annualized volatility, not a bunch of different ones.

A measure I use, and what I used many years ago that still works today, is the 25 delta call to the ATM cal IV on a 30 day option. 30 years ago, all we had was 30 day options because the exchange could not handle any more quote traffic. Anytime that 25 delta call is 90% of the ATM IV or greater, the skew is historically high on the upside. That means traders are buying more calls than usual.

10.43/10.95 is 95% which is a very high number. See the snap above.

Traders are baking in high upside move potential. It might happen or it might not but any dovish Fed and 4900+ is an easier barrier to break. Check out the Trading Desk to see how we are trading it.

To Your Trading Success,