Hi, Could anyone share some thoughts on skew trading: trading theoretical skew versus implied skew?. I have just heard about this and was wondering if there are any useful references on this topic : presentations/articles... Or, at least, could anyone confirm whether skew trading is really used in practice successfully ? Is it worth looking into it?Thanks.

Hi,It's quite difficult to manage your theoretical skew versus implied skew , so you should have used a model that couldindepently calibrate today's market smile and specify its future dynamics. Moreover, you could establish some risk reversalsthat will replicate your vanna risk and in the same case will hedge your skew.Maybe you could read articles published by Schonbücher (1999)....

Here is a link to a useful reference:

This book (Inside Volatility Trading) seems more theoretical than its title would have... Fortunately for quants, nobody has yet demystified what's behind the skew, and where it should be...

In ancient times, everyone said "yes yes, the skew of the markets is about zero, or statistically insignificant - it is only there because of supply and demand." Then the question was "well in that case, why doesn't someone sell the skew, delta hedge and make a ton of money?" Then the room would grow deathly quiet and everyone would look gravely at the person who said this, and finally one person would say "where were you in 1987?"So the notion was that the real skew "ought" (from the stats) to be about zero, but nobody wants to have sold the skew and delta hedged, and then see the market go down 20%+ again. The boss wouldn't want to hear about statistical significance - he would hand you a bag for your personal belongings.So common knowledge was that skew ought to be zero, but nobody could short OTM puts and buy OTM calls unless they were totally insane. They would make money hand over fist and then there would be a big noise on the trading floor and a smoking crater would be where Mr Short Skew had been sitting.Then a funny thing happened - nothing! After 18 years, no 15% or 20% crashes! But people still didn't generally short the skew as a major trading strategy, as the bosses who saw 1987 still think it is an insane strategy. And they are probably actually right, if all you do is short OTM puts buy OTM calls and delta hedgeBut now the market DOES act skewier, though maybe still not as skewy as the implied vols imply. Funnily enough, there is a strategy you can use to short the skew without taking any crash risk. I have used it multiple times and made money most of the time. In a crash you would make money, not lose it, as you are overall long the fail tail. But you have to take volatility curve risk, and you have to be net long vol.It involves basically buying a longer dated ATMF straddle and selling a strip of shorter dated OTM puts such that the day before expiry your PNL, delta and gamma look like a sine wave, down to a certain point, and then you go long gamma below this point again.That's how i've traded the skew. It's not arbitrage, because you have open vol risk and vol term structure risk, but it tends to work if you're not in a falling vol market.

sorry to revive this old thread Erstwhile, please could you elaborate your strategy a little further with some examples on strikes etc. Is there something similar in nature for going long skew apart from the usual , sell a put spread , buy a call spread , buy an itm call, or even sell an ITM down and out put ? I would appreciate any helpThanks

Hi - I am looking into skew trades on equity as well. I am looking at single stocks skew vs their relative index skew and I am trying to take into account the beta of the stock in my model. Since the beta is in some way the volatility to the index I feel there is something that could be looked at when trading the skew. Looking forward to your inputs - Tks