Our previous post discussed how the implied volatility (IV) of OTM puts are often higher than the IV of OTM calls. We would like to add that this “smirk” is very much warranted – it is not an invitation to sell OTM puts. Returns of financial instruments often have negative skew – a fancy way to say that they often take an escalator up, and an elevator down.
Here are the daily and weekly return skews of the NIFTY 50 TR index and the SPY ETF:
The market is willing to pay up to hedge against this risk. If you sell the skew, you’ll have to hedge against it by some other means. Otherwise, it is like picking up pennies in front of a bulldozer.