This options-based strategy observes the difference in implied volatility between two strikes. When the skew diverges from its historical average by a large margin, it opens a position expecting the skew to revert.
A long skew trade buys the cheaper-volatility option and sells the expensive one when the skew exceeds Threshold standard deviations above the mean. A short skew trade does the opposite when the skew falls below the mean by the same amount. Positions are closed when the skew moves back toward its average level.
The strategy is designed for experienced traders familiar with options pricing. Stop-loss protection is used to guard against persistent shifts in volatility expectations.
Entry Criteria:
Long: Volatility skew > average + Threshold * StdDev
Short: Volatility skew < average - Threshold * StdDev
[]Long/Short: Both sides.
[]Exit Criteria:
Long: Exit when skew returns toward average
Short: Exit when skew returns toward average
[]Stops: Yes, percent stop-loss on option positions.
[]Default Values:
LookbackPeriod = 20
Threshold = 2m
StopLossPercent = 2m
[*]Filters:
Category: Arbitrage
Direction: Both
Indicators: Volatility Skew
Stops: Yes
Complexity: Advanced
Timeframe: Intraday
Seasonality: No
Neural networks: No
Divergence: Yes
Risk Level: High