Q&A with McMillan: The Reverse Skew

By Lawrence G. McMillan

One of our customers recently asked a good option-related question regarding premium in index options.  This is a fairly common inquiry so I figured my response is worth sharing with everyone.  See the question and answer below. 

Customer:

Hi Larry,

I see ES call premium is much less than put premium for equal distance strikes. Does this mean market is bearish biased?

As of today, the Oct 18 1725 call is 1.95 and 1665 put is 5.5 when RS 12-13 is at 1695.

McMillan:

That is called "negative skew" or a "reverse skew".  It has been in existence since 1987 in broad-based index options, such as ES but also SPY, SPX, OEX, etc.  It is just a natural function of the demand for protection (increased put price) margin requirements (even market makers have to margin naked puts, since the Crash of 1987) and a penchant for selling index calls (as protection) by institutions.  So it doesn't have any meaning as far as predicting the market.

Some analysts have tried to relate the steepness of that skew to market predictions, but their results have been spotty at best.

For more information on the reverse skew, refer to Options As a Strategic Investment.