Volatility Skew

Not all options on the same stock have the same implied volatility. If they did, the Black-Scholes model would be perfect and the real world would be simple. Instead, we have volatility skew — and understanding it gives you an edge in trade construction.

What Is Volatility Skew?

Pull up any option chain. Look at the implied volatility column for a single expiration. You will notice:

OTM puts have higher IV than ATM options
OTM calls have lower IV than ATM options
ATM options sit in the middle

This pattern — higher IV on lower strikes, lower IV on higher strikes — is called the volatility smile or skew. On equity options, it is specifically called a "smirk" because the left side (puts) is steeper than the right side (calls).

Why Does Skew Exist?

Demand for downside protection. Institutional investors buy OTM puts to hedge portfolios. This constant demand drives up put premiums and therefore put IV.

Fear of crashes. Markets crash fast and rally slow. The probability of a 10% drop in a week is higher than a 10% rally. OTM puts need higher IV to account for this fat-tail risk.

Supply and demand mechanics. Market makers who sell OTM puts take on significant risk. They charge more (higher IV) to compensate. Meanwhile, there are natural sellers of OTM calls (covered call writers), which keeps call IV lower.

Measuring Skew

The simplest measure: compare the IV of the 25-delta put to the IV of the 25-delta call at the same expiration.

Example on SPY, 30 DTE:

25-delta put IV: 18%
ATM IV: 15%
25-delta call IV: 13%
Skew: 5 points (25-delta put IV minus 25-delta call IV)

A steeper skew (7+ points) means puts are relatively expensive compared to calls. A flatter skew (2-3 points) means puts and calls are more equally priced.

How Skew Affects Your Trades

Selling put spreads: High skew means you collect more premium on puts. The $430 put on SPY has higher IV than the Black-Scholes model would suggest. When you sell it, you are collecting inflated premium. This is one reason put credit spreads are so popular.

Selling call spreads: Lower IV on calls means less premium collected. Bear call spreads are often less rewarding than bull put spreads on the same underlying, even with the same width and delta.

Iron condors: The put side will always collect more than the call side due to skew. Some traders capitalize on this by making the put side wider or closer to the money to capture the skew premium.

Trading Skew Directly

You can construct trades that explicitly profit from changes in skew.

Skew is steep (puts are very expensive relative to calls): Strategy: Sell the put side aggressively, buy it back when skew normalizes.

Risk reversal: Sell an OTM put and use the credit to buy an OTM call.

Example: SPY at $450. Sell the $430 put for $5.00, buy the $470 call for $3.50. Net credit: $1.50.

This trade profits if SPY goes up (the call gains value), stays flat (both expire worthless, you keep $1.50), or drops moderately above $430 (put expires worthless). It loses if SPY drops below $428.50. You are essentially getting paid for the skew premium in the puts and using it to finance cheap calls.

Skew is flat (puts and calls priced similarly): This is unusual and often happens after a sharp rally. Puts become cheap relative to their normal levels.

Strategy: Buy OTM puts cheaply as hedges. Or enter calendar spreads on the put side where you benefit from skew returning to its normal steep state.

Skew Across Different Underlyings

Skew varies significantly by underlying:

SPY/SPX: Steep skew. Institutional hedging demand keeps put IV elevated. Skew typically 4 to 8 points.

Individual tech stocks (AAPL, MSFT): Moderate skew. Less institutional hedging, more speculative call buying. Skew 2 to 5 points.

Meme stocks/High IV names: Can have inverted or flat skew. Call IV sometimes exceeds put IV because retail traders are buying calls aggressively. TSLA and GME have shown call skew at various points.

Commodities (GLD, SLV, USO): Often have a different skew shape — more symmetrical or even slightly call-heavy, because commodities can spike in either direction.

Using Skew in Strategy Selection

When choosing between equivalent strategies, let skew guide you:

Bullish on AAPL:

If put skew is steep: Bull put spread (you sell expensive puts)
If call skew is flat: Bull call spread (you buy cheap calls)

Bearish on TSLA:

If call skew is elevated (common for TSLA): Bear call spread (sell expensive calls)
If put skew is flat: Bear put spread (buy cheap puts)

This is a subtle optimization that adds 0.5% to 1.5% per trade in edge. Over hundreds of trades, it matters.

Skew Changes Before Events

Before earnings, skew often steepens as traders buy protective puts. After earnings, skew flattens as the uncertainty is resolved.

Before a Fed meeting, skew steepens. After the announcement, it normalizes.

If you trade around these events, timing your entries for post-event skew normalization can improve your pricing. Enter the bull put spread after earnings when put skew has flattened and put premiums are relatively cheaper.

Monitoring Skew

Most platforms show IV by strike. To monitor skew:

Note the IV of the 25-delta put and 25-delta call at your target expiration
Calculate the difference (put IV minus call IV)
Compare to the stock's average skew over the past month
If current skew is steeper than average, favor selling puts. If flatter than average, favor buying puts.

Advanced traders track skew daily on their core underlyings and use it as a trade filter. It takes 5 minutes and is one of the easiest edges to exploit.

Skew is the hidden dimension of options pricing. Once you see it, you cannot unsee it. Next: a deep dive into LEAPS — long-term options with unique properties.