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Trading options using Implied Vol Skews - Puts vs. Calls

In today's edition of our volatility comment we want to focus on skew plays. We have culled from all of our scans a candidate list of very high and very low skews (the ratio of implied volatility for calls versus the implied volatility for puts) in which some trading strategies might be designed.

Skews for most individual stocks are normally non-existent. The lack of a skew or a neutral reading of around 1.00, suggests that there is no strong overriding bias for either call or put options by market participants. However, occasionally you do see the market for a particular stock's calls or puts get out of alignment. This is due to either a bidding up of one type of option, a selling of the other type of option or a combination of those activities. However, when a skew situation exists there maybe a reasonable explanation for it- (a takeover rumor, a product announcement, a legal decision, etc) so check the news. However, if there is no news there may be a trading opportunity because the market has simply got ahead of itself.

The trading opportunity arises from the concept of sentiment. In this concept, contrarian investors look toward various trading data for ideas in which to go opposite of the crowd's opinion. We may have some contrarian ideas here today courtesy of our skew scan. According to our scans the top stocks in which call implied volatility is greater than put implied volatility are:

Symbol Stock Rating Meaning
X US Steel 1.07 Call IV is greater than Put IV
GT Goodyear Tire 1.06 Call IV is greater than Put IV
BUD Anheuser Busch 1.06 Call IV is greater than Put IV
AVP Avon Products 1.05 Call IV is greater than Put IV

The two to watch closely in that group is BUD and AVP.

According to contrarian opinion these stocks may be candidates for your trading list today as there is a preponderance of calls to puts. If there is no news to support this call buying position, you may see a reversal of fortune and the stock fall as participants jettison their long call positions.

On the opposite side, the following stocks have higher put implied volatilities than call implied volatilities:

Symbol Stock Rating Meaning
BAC Bank America 0.95 Put IV is greater than Call IV
F Ford Motor 0.95 Put IV is greater than Call IV
PG Procter & Gamble 0.95 Put IV is greater than Call IV
MRK Merck 0.95 Put IV is greater than Call IV
EMR Emerson Electric 0.95 Put IV is greater than Call IV
SNV Synovus Financial 0.94 Put IV is greater than Call IV
LTR Loews Corp. 0.94 Put IV is greater than Call IV
ETR Entergy Corp. 0.94 Put IV is greater than Call IV

Correlation Scans
If you are looking for a clue as to how the whole market may do or a cheap way of mirroring the S&P 500 Index (SPX) then look no further than to America Online (AOL), Sun Microsystems (SUNW), Conexant Systems (CNXT) or Inktomi (INKT). All of these have correlations in excess of 80 and should be good proxies for trading the SPX. They may even be able to telegraph to you where the market is heading before it actually happens.