pet peeves in options and derivatives...

1) Skew exists for a reason. Realized skew is the covariance between spot prices and implied volatility. Downside put vol trading above at the money vol reflects fact that implied vol rises when markets fall and isn’t “irrational”.

As the market falls, a downside put’s vega (volatility exposure) rises, just as implied volatility is rising. That is a source of convexity which generates returns for the option owner over time and which is compensated by the market in terms of a higher implied volatility.

There might be too much skew risk premium at some point in the curve at some specific time, but actually historically some tenors of skew have had almost no risk premium on average. Need to do your homework on this.

2) Don’t compare long term option implied volatility to short term realized volatility. Long term options have little time decay and most of their risk is vega risk (from changes in implied volatility). Instead look at volatility term premium (slope relative to level).

3) Don’t quote implied volatility moves (eg VIX) in percentages and think that’s meaningful. Implied volatility changes have a much more stationary distribution in vol points than in percent. It doesn’t take much to double implied vol from an initial level of 8.

4) For the love of the gods, don’t sell a put because “you’d love to own the stock down there”. If it gets there, you will have lost a bunch of money first. Sell a put if you think the risk premium you collect gives a significant premium to the probability of the bad event.

5) please stop throwing around dollar numbers of gross derivatives exposure at some bank or in the world. It just doesn’t tell you anything , you’re adding up all kinds of different numbers that aren’t comparable at all.

To give a really dumb example, if you buy a security or an investment strategy on total return swap with a bank, often you can just choose whether you want the 1% volatility version with $1000 notional, or the 10% version with $100 notional, etc...

Another example - LTCM’s biggest losses were in short positions on variance swaps. In a bad event $25 million notional of variance swaps could cause billions of dollars of losses. Compare that to short term interest rate swaps which could make or lose a few hundred grand.