Volatility skew is the pattern of implied volatility across the strikes of a single expiry. In US equities and especially in index options, out-of-the-money puts usually carry a higher implied volatility than calls the same distance from the price, so the curve slopes down from low strikes to high strikes.
How it works
The Black-Scholes model assumes one volatility for every strike. Real markets do not price options that way, and since the 1987 crash index options have consistently priced downside strikes higher. Three forces drive this:
- Demand for protection. Portfolio managers buy puts to hedge, while many investors sell calls against holdings for income. Demand for puts and supply of calls push their IVs apart.
- Volatility rises when prices fall. Stock and index declines tend to come with higher volatility, so downside outcomes are priced as more turbulent.
- Crash risk. Large drops have historically happened more often than large jumps in broad indices, and option sellers charge for that tail.
The shape varies. Index options typically show a smirk, steep on the put side and flat on the call side. Some single stocks show a more symmetric smile. Stocks with takeover speculation or heavy speculative call buying can show call skew, with upside strikes priced above downside ones.
How to read it
Comparing options by delta rather than by strike makes skew comparable across stocks and price levels. The most common measures use the 25-delta put and the 25-delta call of an expiry about a month out:
- Put minus call IV, in volatility points (closely related to the risk reversal used in currency markets).
- Put ÷ call IV, a ratio that compares stocks with very different IV levels.
A steepening skew means downside protection is getting more expensive relative to upside exposure, often a sign of rising caution. A flat or inverted skew, with calls as pricey as puts, often points to traders chasing upside. Skew and the overall IV level can move independently: IV can fall while skew steepens.
Skew also shapes how spreads are priced. Within a put spread, the further out-of-the-money leg carries the higher IV, which lowers the net cost of buying a put spread and trims the net credit when selling one. See credit spreads.
Worked example
Illustrative numbers only, not a recommendation. A stock trades at $100; consider the expiry 30 days out.
- 25-delta put (strike near $94): IV 30%.
- 25-delta call (strike near $104): IV 21%.
- Put minus call: 9 points. Put ÷ call: 30 ÷ 21 ≈ 1.43.
That is a pronounced put skew: traders are paying well above the call-side rate for downside protection. If a month later the put shows 24% and the call 24%, the ratio is 1.0 and the skew has flattened, with demand shifting toward upside exposure.
Limitations and common mistakes
- Skew differs by expiry. Short-dated options often show a steeper skew than long-dated ones, so compare readings from similar expiries.
- Thin wings are noisy. Far out-of-the-money strikes can have wide quotes that distort IV.
- Normal skew is not fear. Puts priced a little above calls is the ordinary state for equities. Only a change from the stock's usual reading carries information.
- Skew is not a timing signal. Steep put skew can persist through rallies, since hedging demand often rises as portfolios grow.
- Delta depends on IV. The strike that counts as 25-delta shifts as IV and the price move, so readings are not fixed to one strike.
In Clear Tape
On the Options page, the free SPY, QQQ and IWM index cards show skew as the put ÷ call IV ratio. Pro members get the Skew and volatility panel for any stock: 25-delta put and call IV with their strikes, put minus call in points, and put ÷ call, taken from the expiry closest to 30 days with at least 7 days left. A ratio of 1.25 or more reads as fear, 1.0 or less as chasing, anything between as normal; the first two also appear as Put skew and Call chase flags in the summary and the watchlist scan. Member data reflects the previous session's close. For the broader mood picture, see the fear and greed index; plans are on pricing.
For educational purposes only. Not investment advice.