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How Stock Crashes Can Steepen Single-Stock Option Smiles

Article Quant Q&A · Author: Slow Learner
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Summary

The document addresses whether individual-stock option volatility smiles become steeper after sharp declines. Its answer describes a common market pattern: implied volatility, especially for out-of-the-money puts, tends to rise after a stock price falls. A market maker may therefore raise implied volatility on the downside of the smile as the stock’s perceived risk increases.

The explanation is qualitative and offers no empirical study, sample, or quantitative measurement of the effect. It suggests a risk-based market-making rationale rather than establishing that every stock crash produces the same change or specifying how long the change lasts. The observation concerns single-name equity options and the left side of their implied-volatility surfaces.

Key ideas

  • Out-of-the-money put implied volatility commonly rises after a stock price decline.
  • Market makers may steepen the downside of a single-stock volatility smile when perceived risk increases.
  • The explanation is qualitative and does not quantify the size or persistence of the effect.

Tags

OptionsEquitiesVolatilityMarket making
Full text
# Do single name stock option volatility surfaces exhibit steeper volatility smiles after stock price crash episodes?


# Do single name stock option volatility surfaces exhibit steeper volatility smiles after stock price crash episodes?












In index options, there was not much of a smile (on the put-side) until the 1987 market crash.

I'm wondering if the same applies to single name stocks? That is, do price crashes in individual stocks trigger smiles in their option surfaces?

## Answer by Xomuama (score 1)

https://quant.stackexchange.com/a/65564

Yes, it is very very common that implied vol, and particularty that of OTM puts, increases after crashes, even after limited losses.

A market maker will have a tendency to increase its volatility on the left side of a smile if a stock price drops, because the risk inherent to that stock is considered higher.

Hope it helps.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.