Historical Volatility Skew
Volatility skew, also called the IV smile or smirk, shows how implied volatility varies across different strike prices. Analyzing historical skew patterns helps traders identify mispricings, understand market sentiment, and predict potential market moves.
What Is Volatility Skew?
Volatility skew refers to the pattern of implied volatility across strikes:
- Put Skew: Downside puts have higher IV than ATM (protective puts premium)
- Call Skew: Upside calls have higher IV than ATM (tail risk pricing)
- Smile: Both wings have elevated IV (uncertainty in both directions)
Why Skew Matters
Market Sentiment Indicator
- Steep put skew: Fear of downside, protective buying
- Steep call skew: Upside uncertainty or event risk
- Flat skew: Neutral sentiment or complacency
Trading Opportunities
- Overpriced options: High IV strikes to sell
- Underpriced options: Low IV strikes to buy
- Relative value: Compare skew to historical norms
Chart Components
Skew Curve
- X-Axis: Strike prices (or moneyness %)
- Y-Axis: Implied volatility (%)
- Call Curve: Green line showing call IV by strike
- Put Curve: Red line showing put IV by strike
- ATM Marker: Reference point at current price
Key Metrics
- Skew Steepness: How rapidly IV changes with strike
- 25-Delta Skew: IV difference between 25-delta put and call
- 90/110 Skew: IV at 90% vs 110% of spot price
- Minimum IV: Usually occurs near ATM
Historical Analysis Use Cases
Trend Identification
Increasing Put Skew:
- Growing fear or uncertainty
- Hedging demand increasing
- Often precedes market weakness
- Can indicate volatility regime change
Decreasing Put Skew:
- Reducing fear
- Complacency increasing
- Often occurs in strong uptrends
- May signal overconfidence
Mean Reversion Trading
- Extreme skew often reverts to mean
- Historically steep skew suggests overpricing
- Flat skew in typically skewed markets suggests underpricing
- Compare current skew to historical range
Event Risk Pricing
- Earnings approach: Skew often flattens (straddle buying)
- Post-earnings: Skew normalizes (IV crush)
- Special events: Directional skew based on expected impact
- Binary events: Often create call or put skew
Interpreting Skew Patterns
Normal Equity Skew (Put Skew)
- Puts more expensive than calls at same delta
- Reflects crash insurance premium
- Typical in bull markets
- Historical norm for stocks
Reverse Skew (Call Skew)
- Calls more expensive than puts
- Often seen in:
- Commodities (supply disruption fear)
- Takeover targets (upside cap uncertainty)
- Momentum stocks (FOMO)
- Beaten-down stocks (recovery potential)
Symmetric Smile
- Both wings elevated equally
- Indicates:
- Binary event (earnings, FDA approval)
- High uncertainty in both directions
- Potential large move, direction unknown
- Often before major announcements
Trading Strategies Based on Skew
Skew Trades
Sell Expensive Wing:
- Sell overpriced far OTM puts when skew is steep
- Sell call skew when calls are elevated
- Use spreads to define risk
Buy Cheap Wing:
- Buy relatively cheaper side of skew
- Ratio spreads to take advantage
- Calendar spreads at different skew points
Relative Value
- Compare current skew to historical average
- Trade deviations from norm
- Sell abnormally high skew, buy abnormally low
Volatility Arbitrage
- Exploit skew mispricings
- Delta-hedge to isolate volatility
- Capture mean reversion in skew
Skew by Market Condition
Bull Markets
- Typical: Moderate put skew
- Risk: Complacency flattens skew dangerously
- Opportunity: Cheap downside protection
Bear Markets
- Typical: Extreme put skew
- Risk: Overpaying for protection
- Opportunity: Sell elevated put premium
High Volatility Environments
- Typical: Overall higher IV across all strikes
- Skew: Often steepens significantly
- Trading: Sell premium strategies more attractive
Low Volatility Environments
- Typical: Flatter skew
- Risk: Underpricing of tail risks
- Trading: Cheap protection, long volatility plays
Advanced Skew Analysis
Skew Momentum
- Increasing skew: Fear building
- Decreasing skew: Fear subsiding
- Rapid changes: Important sentiment shifts
- Divergences: Skew vs price action
Term Structure + Skew
- Near-term skew vs far-term skew
- Event impact on skew
- Skew changes across expirations
- Calendar spread opportunities
Skew vs Realized Volatility
- Skew predicts tail moves
- Compare to actual tail movements
- Identify if tail risk over/underpriced
- Historical accuracy of skew pricing
Best Practices
Analysis Workflow
- Check current skew vs historical average
- Identify any unusual patterns or extremes
- Consider market context and upcoming events
- Compare to other volatility indicators
- Determine if current pricing is rational
Warning Signs
- Extremely flat skew: Potential complacency
- Unprecedented steepness: Possible panic
- Sudden skew changes: Major sentiment shift
- Skew divergence from fundamentals: Potential mispricing
Common Pitfalls
- Assuming skew always mean reverts (it doesn’t)
- Ignoring upcoming catalysts
- Not adjusting for market regime changes
- Over-trading small skew variations
Integration with Other Indicators
Put/Call Ratios
- High put/call + steep put skew = extreme fear
- Low put/call + flat skew = complacency
- Divergences may signal reversals
Volume Analysis
- High volume in skewed strikes confirms pricing
- Low volume in expensive strikes = fade opportunity
- Volume shifts can predict skew changes
Price Action
- Skew should align with technical levels
- Support/resistance affects local skew
- Breakouts often compress skew
Data and Availability
Calculation: IV extracted from option prices using Black-Scholes Strikes Analyzed: Typically 10-20% OTM on each side Expirations: Focus on near-term (30-60 DTE) for most liquid data Historical Data: 15+ years available Update Frequency: Daily Subscription: Delta plan and higher
Example Scenarios
Pre-Earnings
- Before: Flat skew, elevated overall IV (straddle buying)
- After: Skew normalizes, IV crushes
- Trade: Sell elevated IV before event
Market Correction
- During: Steep put skew develops
- Recovery: Skew slowly normalizes
- Trade: Sell put premium as fear subsides
Takeover Rumor
- Develops: Call skew emerges (upside uncertainty)
- Resolution: Skew disappears if deal announced
- Trade: Buy cheap puts (hedge), sell elevated calls
Disclaimer: Skew analysis is probabilistic and doesn’t guarantee outcomes. Always consider skew in context of broader market analysis and use proper risk management.
