Volatility skew pricing refers to the phenomenon where implied volatilities for options with different strike prices but the same expiry date are not uniform. Instead, they form a characteristic curve, or “skew,” when plotted against strike prices. In crypto options, this pricing anomaly reflects market participants’ differing perceptions of risk for out-of-the-money versus in-the-money options, often indicating a preference for protection against extreme price movements.
Mechanism
The skew arises from supply and demand imbalances for various option strikes, influenced by factors such as perceived tail risks, historical price behavior, and market maker hedging activities. Options pricing models, while typically assuming constant volatility, are adjusted to account for this empirical observation, using techniques like local volatility or stochastic volatility models. This adjustment results in options being priced with implied volatilities that vary by strike.
Methodology
Institutional crypto options traders apply volatility skew pricing models to assess relative value, construct delta-neutral strategies, and manage portfolio risk. By accurately modeling the skew, traders can identify mispriced options or structure complex options strategies, such as straddles or risk reversals, with a more precise understanding of their expected payouts. This systematic approach is crucial for effective risk management and competitive RFQ submissions in volatile digital asset markets.
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