Custom Analytics provides a Microsoft Excel add-in program that allows you to value options using custom functions using the Derman Skew methodology.
- Derman Skew Regimes of Volatility
Volatility Skews
Option pricing models assume that market returns are lognormally distributed, where the skew and kurtosis of the distribution are equal to 0. Because most markets returns are not lognormally distributed volatility skews are observed. We see each strike with a different unique implied volatility calculated using Black-Scholes or binomial models. Below are several examples of observed skews in the marketplace.
An in-depth discussion of the various historical volatility skews observable in the stock market is contained in Goldman Sach’s Quantitative Strategies Research Notes – Regimes of Volatility –
Some Observations on the Variation of S&P 500 Implied Volatilities – [link to paper]
FinTools software can use option quotes and calculate the implied volatility of the real-time market. Using the observed skew, our skew calculating functions can then calculate greeks taking into account that volatility will be shifting as the stock price moves. For example, if you estimate that volatility decreases as the stock price goes up the actual delta of a call will be less than the Black Scholes delta because it factors in the decrease in value due to the decrease in volatility.
Key Concepts
Volatility Skews
Sticky Strike
Sticky Delta
Investment Skews, Volatility Smiles Commodity Skews and Volatility Smirks.