By Steve Lentz
For years now, options traders and market observers have used the VIX as a measure of expected volatility. The rules of thumb may vary, but usually a line-in-the-sand exists around 15 or so. When the VIX is above 15, watch out for the bears. When it’s below 15, all systems are a “go” for the bulls. You get the picture.
But, when evaluating expected volatility, SPX Butterfly and Condor traders need more than just a single VIX figure. Why? Because the SPX options have a very interesting characteristic.
The put options imply a different expected volatility than the call options.
Take a look at the matrix of options below
The MIV for each contract represents the implied volatility of the mid-point between the bid and ask prices.
Notice how the calls have lower and lower MIVs as they get further out of the money. Now see how the put MIVs get higher and higher as they drift further out of the money. These differences are called the “vertical volatility skew”, and this general pattern has existed since 1987 when the stock market crashed and out-of-the-money put sellers were “carried out on their shields” as the saying goes. The skew we see now is a testament to that debacle.
So, what does this mean for the SPX options premium seller? Well, if you want a true estimation of market movement, you will need to establish one level for the upside move and another more distant level for the downside move. Using one level for both sides would not reflect what the market is truly telling us.
Here at Volatility Timer, both of our timing advisories take this difference into account and its consideration goes into the advisory algorithms. For more information, please visit our SPX Condor/Butterfly Timing Report page.