​Russell’s Maidel & Pedack: Volatility Skew and Volatility Management

The market crash of 1987 was nearly three decades ago but had everlasting effects on the world’s options markets. Volatility skew, which is the higher prices associated with equity index puts versus equivalent percent out-of-the-money calls, was not evident in equity options till post Crash of 1987. We now see a new dynamic driving skew to higher levels. New regulations aimed at Wall Street are causing bank balance sheets to shrink and reducing their risk taking. As banking regulation is introduced, Wall Street trading desks are increasingly unable to carry significant amounts of downside risk which is altering the volatility landscape.