“Option skew” refers to the difference between the implied volatility of call and put options with the same delta. It can provide information about market expectations and potential future developments.
Millennium Global considers that option skews are an important early warning indicator of potential sharp market movements. In managing currency exposures such warnings will encourage us to be more risk averse, in particular in our Dynamic Hedging strategy. For example, the GBP/USD spot rate was relatively stable prior to the Brexit vote but the option skew was at an extreme. This told us that if there was a surprise in the vote, there could be a very large market reaction.
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