There has been an interesting shift in how options investors value puts since the February VIX debacle.

The put call skew was falling as the markets rallied into January 2018. Then, February happened. Slope rose and stayed that way. Recently, slope has increased to almost year highs. Slope or skew as described below, measures the relative level of lower strike implied volatility vs high strikes. When investors start to buy more out-of-the-money puts, the implied volatility rises and the slope goes up.

It is tough to predict the future market based on skew, but since February the old saying 'Wall Street climbs a wall of worry' (with expensive puts a proxy for worry) has been cogent.

Implied Volatility Surface

An implied volatility surface can be described as a 3-dimensional surface where the independent variables are time to expiration, and option delta and the dependent variable is implied volatility.  To illustrate an implied volatility surface, we have developed a 2-dimensional graph that displays all three axes in the figure below.  Summary information about this surface gives the trader a macro view of the implied volatilities for each option chain. ORATS takes a snapshot of all options on all symbols approximately 10 minutes before the close of trading. Options markets from this time are often of higher quality than at the close.

ORATS measures the surface using the following summary characteristics: at-the-money volatility, strike slope, derivative, and earnings effect.

The “Smile”

At-the-money volatility is the implied volatility at the 50 delta call and put, or in other words, at the straddle.  Strike Slope is a measure of the amount that implied volatility changes for every increase of 10 call delta points within the intra-month skew.  It measures how lopsided the 'smile' or 'smirk' is.  The derivative is a measure of the rate at which the strike slope changes for every increase of 10 call delta points within the intra-month skew.  It measures the curvature of the intra-month skew or 'smile.' We chose just two parameters to describe the skew to get a reasonable fit for the fewest assumptions.

Using this method of describing the skew has the additional benefit of producing accurate at-the-money volatility readings important for summarizing the term structure.


Download an explanation about skew and ORATS data HERE

Watch a video about skew here: API analyze skew in ETFs:

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