View article

Since the 1987 crash, option prices have exhibited a strong negative skew, implying higher implied volatility for out‐of‐the‐money puts than at‐ and in‐the‐money puts. This has resulted in incorporating multiple jumps and stochastic volatility within the data generating process to improve the Black–Scholes model in an attempt to capture negative skewness and a highly leptokurtic distribution. The general conclusion is that there is a large jump premium in the short term, which best explains the significant negative skew for short maturity options. Alternative explanations for the negative skew are related to market liquidity driven by demand shocks and supply shortages. Regardless of the explanation for the negative skew, we assess the information content in the shape of the skew to infer if the option market can accurately forecast stock market crashes and/or spikes upward. We demonstrate, using all options on the …