The use of different quoting conventions across instruments is not arbitrary. It reflects careful and pragmatic choice that minimizes the need for market-makers to re-quote bid/ask each time the underlying market moves. For example, implied volatilities require fewer bid/ask adjustments than dollar premiums because they are less directly influenced by the delta effect.
Similar reasons exist when it comes to distinction between quoting options on FX and on equity markets.
🟥 Sticky Delta
FX and Rates markets are known for having "sticky delta", meaning that the entire volatility smile tends to follow the underlying. In such situations, it is beneficial to use relative strikes (e.g. calculated from 10C, 25C, ATM, 25P, 10P deltas) or, even better - butterflies and risk reversals (Figure 1).
🟩 Sticky Strike
On the other hand, equity markets tend to have "sticky strike" (in dollar terms). That means the volatility surface is "pinned" to the absolute strikes, and any movement in the underlying spot affects the implied volatility points read off from that volatility surface, rather than shifting the entire surface itself (think of the vanna/volga effects).
This mechanism is relatively straightforward. However, few questions remain:
Why do FX markets mostly operate in a sticky delta regime, while equities have sticky strikes ? Is this observation universally true ? There are multiple economic theories that offer explanations. Some are better than others, but none of them is fully falsifiable, as is often the case.
💡I found the following idea particularly intriguing:
Previously, I mentioned that the "quoting conventions" have been carefully chosen (or organically evolved) in order to conveniently accommodate the market characteristics and make market-makers' life easy.
But what if there is a feedback loop ? What if the choice of quoting language we use also affects the market behavior ? What if FX markets exhibit sticky delta precisely because we use ATMs, butterflies, and risk reversals to quote them ? What if equity vols are stuck to the dollar strikes partially because the way how equity strike ladders are structured ?
Outside finance, there are multiple hypotheses of linguistic relativity, which suggest that language structures affect the way people think and the decisions they make. Quoting conventions are part of the "language of markets". Perhaps this language partially affects the stickiness of vol surfaces ?
Answers to this are beyond the scope of this post.