Options Skew Explained: Volatility Skew

By the RadarPulse Markets Team

In a textbook options model, every option on the same stock with the same expiry would share a single implied volatility (IV) number. In practice, they do not. Options at lower strike prices often trade at meaningfully higher IV than options at higher strikes. That difference is volatility skew. Understanding skew tells you where the market is placing its fear, which side of a trade the crowd is hedging, and when unusual positioning may be worth tracking.

What volatility skew is

Volatility skew is the observation that options at different strikes carry different implied volatilities, even when they share the same underlying asset and expiry date. If you take a single stock or index and look at every available strike for a given expiry, then back out the implied volatility from each option's market price, the IV numbers will not be flat. They will form a curve.

That curve exists because implied volatility is not a fixed property of the underlying asset. It reflects the supply and demand for each individual contract. When more buyers crowd into one strike than another, the price of options at that strike rises, and the IV backed out of that price rises with it.

The shape of the IV curve reveals which strikes are in demand and why.

Put skew: negative skew (left skew)

The most common pattern in equity index options is put skew, also called negative skew or left skew. Out-of-the-money (OTM) puts carry higher IV than at-the-money (ATM) options, which in turn carry higher IV than OTM calls.

The reason is structural. Equity markets can fall sharply and quickly. A 20% drawdown can happen in weeks; a 20% rally of the same speed is rarer. Institutions holding large equity portfolios routinely buy OTM put options as tail-risk hedges. That persistent demand for OTM puts inflates their price relative to what a simple model would predict, which shows up as elevated IV on the put side of the chain.

After the 1987 market crash, equity index skew became a permanent feature of options markets. Before that event, IV curves were much flatter. The crash demonstrated that large downside gaps were a real possibility, and the market has priced that risk ever since.

Put skew is particularly pronounced on index products such as SPY, SPX, and QQQ. Individual stocks show skew too, though it tends to be less severe than on indices.

Call skew: positive skew (right skew)

Not every market shows put-heavy skew. When OTM calls trade at higher IV than ATM or OTM puts, the curve exhibits call skew, also called positive skew or right skew.

Call skew is more common in commodity markets. Oil, natural gas, and agricultural commodities can spike violently to the upside on supply disruptions. Buyers of those underlying assets hedge against price surges by purchasing OTM calls, driving up call IV relative to put IV.

In equity markets, call skew can appear on individual stocks during periods of heavy speculative interest. Heavily shorted names, high-momentum stocks, and names with active retail positioning sometimes show elevated OTM call IV when traders aggressively buy upside calls anticipating a squeeze or a catalyst. This kind of call skew spike is a signal that options flow watchers pay close attention to.

The volatility smile and the volatility smirk

When you plot implied volatility on the vertical axis against strike price on the horizontal axis, the resulting curve has a name that describes its shape.

The volatility smile is a roughly U-shaped curve. Both OTM puts and OTM calls carry higher IV than at-the-money options, creating a curve that rises on both wings. The smile is common in currency (FX) options markets, where both large upside and downside moves are plausible, and in very short-dated equity options where both wings get bid up before a binary event.

The volatility smirk (also called a sneer or simply "the skew") is an asymmetric curve. The left wing rises steeply as strikes move lower, reflecting expensive OTM puts. The right wing is relatively flat or only modestly elevated. The smirk looks like a curve that slopes steadily downward from left to right, with OTM puts at the high point and OTM calls at the low point. This is the typical shape for equity index options like SPY and SPX under normal conditions.

In practice, "volatility skew" in equity markets nearly always refers to the smirk pattern. A true symmetric smile is less common in equity index options.

How to measure skew

There are two practical ways to quantify skew.

1. The 25-delta rule: The most widely used skew measure compares the implied volatility of the 25-delta put to the implied volatility of the 25-delta call on the same expiry. A 25-delta put is a moderately out-of-the-money put; a 25-delta call is a moderately out-of-the-money call. Subtracting call IV from put IV gives a single number:

Skew = 25-delta put IV minus 25-delta call IV

A positive result means put skew (OTM puts are more expensive). A negative result means call skew (OTM calls are more expensive). A result near zero means the IV curve is relatively flat.

2. OTM-to-ATM comparison: A simpler approach compares a specific OTM strike IV to the ATM IV. For example: take the put 10% below the current price and compare its IV to the at-the-money straddle IV. The wider the gap, the steeper the put skew.

Skew example: SPY options

The following table illustrates a typical equity index skew pattern using SPY options with 30 days to expiry. Values are illustrative.

Skew = 25-delta put IV minus 25-delta call IV = 22% minus 16% = 6%

The OTM put trades at a 4-point IV premium to ATM and a 6-point premium to the OTM call. This is a normal skew environment for an equity index. A reading significantly above 6% would indicate elevated hedging demand; a reading near zero or negative would signal unusual call-buying pressure.

How skew changes around events

Skew is not static. It expands and contracts with market conditions.

Before earnings: Implied volatility rises broadly as traders price in the binary uncertainty of an earnings print. The skew often steepens because both put buyers (hedging against a miss) and call buyers (speculating on a beat) increase activity, but the put side frequently sees more demand on large-cap names where institutional holders need to hedge. After the earnings release, IV collapses (the "IV crush"), and skew typically resets toward its baseline.

Before macro events: Federal Reserve meetings, inflation data releases, and geopolitical developments can drive skew higher in the days leading up to the event. Hedgers buy index puts to protect portfolios against an adverse outcome. Post-event, skew often reverts as uncertainty resolves.

During market stress: When the VIX spikes and the market sells off, put skew typically accelerates. The demand for downside protection surges while call demand fades. Skew levels seen during panic periods are often multiples of their calm-market baseline.

In low-volatility, trending markets: Skew tends to flatten. With the market grinding higher and realized volatility low, demand for OTM puts softens and the IV premium on the put wing compresses.

What unusual skew tells options flow watchers

Skew is one of the core signals that options flow analysts monitor because it reveals directional bias in positioning.

Steep put skew: When put skew expands sharply above its recent average, it signals that buyers are aggressively seeking downside protection. This can be a sign of institutional hedging ahead of expected volatility, or it can precede a period of market stress. A sudden put skew spike on an individual stock, for example, may indicate a large holder is buying protective puts before a catalytic event.

Call skew spike: When OTM calls trade at a premium to puts, it can signal aggressive bullish positioning. On individual equities this sometimes appears ahead of a short squeeze, an activist announcement, or heavy retail-driven momentum. A stock that suddenly develops call skew after a long period of put skew is worth tracking in the options flow.

Skew divergence between index and single stocks: When index skew is steep but a component stock's skew is flat or call-side, the stock may be drawing buying interest despite a nervous broader market. This kind of divergence is a signal that sophisticated flow readers look for when evaluating conviction in a trade.

Skew does not tell you what will happen. It tells you what the market is paying to position for. Combined with volume, premium, and flow data, skew is a meaningful piece of the positioning picture.

Risk reversals as a skew measure

A risk reversal is a two-legged options strategy that directly prices skew as a traded instrument. In its basic form, a long risk reversal buys an OTM call and sells an OTM put (same expiry, similar deltas). The net premium of that trade reflects how much more expensive one side is relative to the other.

When OTM puts are more expensive (put skew), a risk reversal trades at a negative premium: you pay to own calls and collect less than expected from the put you sell. When OTM calls are more expensive (call skew), the risk reversal trades at a positive premium: you collect more from selling the put than it costs to own the call.

Risk reversals are widely used in FX markets as a real-time skew barometer. In equity markets, options traders often quote the risk reversal spread as shorthand for the skew environment on a given name. For a deeper look at risk reversals as both a skew measure and a directional trade, see the risk reversal guide.

Key takeaways

• Volatility skew means options at different strikes carry different implied volatilities even on the same underlying and expiry.
• Put skew (negative skew) is the norm in equity index markets: OTM puts trade at higher IV than ATM, which trades higher than OTM calls.
• Call skew (positive skew) appears in commodities and sometimes in high-momentum or heavily shorted equities.
• The volatility smirk is the typical equity index shape: IV slopes downward from OTM puts to OTM calls. The smile (elevated on both wings) is more common in FX.
• Measure skew with 25-delta put IV minus 25-delta call IV. A 6-point spread on SPY (22% put, 16% call) is a typical baseline.
• Skew steepens before earnings and macro events; it flattens when volatility is low and markets are trending.
• Steep put skew = hedging demand. A call skew spike = aggressive bullish positioning. Both are signals worth tracking in options flow.
• Risk reversals are the traded expression of skew: the premium reflects which side of the chain is more in demand.

Trading with skew: practical applications for active options traders

Skew analysis is not only a diagnostic tool; it has direct applications in strategy selection and position sizing that improve risk-adjusted outcomes for active options traders. The core insight: when skew is steep (OTM puts are very expensive relative to ATM), buying OTM puts is an expensive proposition, and selling put premium is disproportionately well-compensated. When skew is flat (both sides of the chain are equally priced), the advantage of selling put premium is reduced and the cost of buying call protection is relatively lower.

Strategy selection based on skew: in a steep-put-skew environment, credit spreads using put options (bull put spreads, cash-secured puts) collect more premium per unit of risk than they would in a flat-skew environment. This additional premium comes from the structural put-buying demand that keeps OTM put IV elevated. Conversely, in a high-call-skew environment (unusual for equity indices, more common on individual stocks with speculative interest), bear call spreads collect disproportionately high premium and represent a favorable risk-to-reward structure.

Position sizing based on skew: the steepness of put skew is a proxy for the market's consensus assessment of tail risk. When put skew is at extreme levels (the put-call IV spread is much wider than its historical average), the market is pricing a higher probability of a sharp decline. Position sizes in long equity exposure and bullish options strategies should be reduced during extreme skew environments, since the options market is signaling that hedgers are aggressively preparing for adverse outcomes. Conversely, extreme call skew on an individual stock signals high speculative interest, which can precede either a squeeze (further upside) or a rapid reversal (when the speculative demand fades).

Skew and the risk reversal as a sentiment barometer

The risk reversal, as previously defined, is the options market's direct expression of sentiment bias. Monitoring risk reversal levels over time provides a continuous read on how options traders are positioned directionally at any given moment, which complements the directional signals from price action and fundamental analysis.

When risk reversals are significantly negative (OTM puts much more expensive than OTM calls), the options market has a bearish bias on a net positioning basis: more money is being paid for downside protection than for upside participation. This does not mean the stock will fall; it means that hedgers are actively managing downside exposure. In fact, very negative risk reversals can be a contrarian indicator: when everyone who wants to hedge has already hedged, additional selling pressure may be limited, and any positive catalyst can reverse the position quickly as traders unwind their protective puts.

When risk reversals move toward zero or positive (OTM calls becoming as expensive as or more expensive than OTM puts), the positioning bias has shifted. Speculative call buying is dominating over defensive put buying. This condition appears before short squeezes, momentum runs, and periods when the "fear of missing out" drives aggressive call purchasing. Tracking the direction and speed of the risk reversal shift provides early-warning signals of positioning changes that price action alone often misses.

RadarPulse's flow data contributes to this sentiment analysis by showing where the actual premium is being committed in real time. A high-scoring EXTREME or ELEVATED put buy in a stock that already has steep put skew confirms that sophisticated money is paying elevated prices for downside protection, reinforcing the defensive reading of the risk reversal. A high-scoring EXTREME call buy in a stock with flat or positive risk reversal confirms aggressive bullish positioning, reinforcing the speculative reading of the skew environment.

How skew varies between index options and single-stock options

Skew behaves differently on index options (SPY, SPX, QQQ) compared to individual stock options, and understanding this difference is important for interpreting skew signals correctly.

Index put skew is structurally steeper and more persistent than single-stock put skew. The reason: large institutional portfolios are predominantly long equities, and they systematically buy index puts to hedge their portfolio-level downside risk. This persistent institutional demand for index puts keeps index put skew elevated on an ongoing basis, independent of any specific market conditions. Index skew can spike further during stress events, but even at its baseline, index put skew is steeper than the average single-stock put skew.

Single-stock skew is more variable and more informative as a flow signal precisely because it is not held up by persistent institutional hedging demand. When a specific stock develops steep put skew relative to its own history and relative to similar stocks in the same sector, it is a meaningful signal that concentrated protection-buying is occurring in that name. This can precede earnings surprises, regulatory news, M&A speculation, or management changes that the options market is pricing in before the news becomes public. Monitoring individual stock skew relative to its historical range is one of the most reliable ways to identify when institutional hedging activity is elevated in a specific name.

The comparison between index skew and individual stock skew also provides useful macro context. When index skew is extreme but individual stock skew is moderate, the hedging is occurring at the portfolio level (broad market tail risk) rather than at the individual stock level. When individual stock skew spikes even as index skew remains calm, the concern is stock-specific, not macro-level. This distinction helps options traders understand whether they are looking at a market-wide signal or a company-specific positioning shift.

Skew and options pricing models: why Black-Scholes does not capture it

The original Black-Scholes options pricing model assumes that returns are normally distributed and that implied volatility is constant across all strikes. Both assumptions are incorrect empirically: stock returns have fat tails (large moves are more common than a normal distribution predicts), and implied volatility is not constant across strikes (the skew pattern demonstrates this). Understanding why Black-Scholes fails to capture skew explains why real options chains look different from the theoretical prices that a simple model would produce.

In Black-Scholes, all options at the same expiry on the same underlying would have the same implied volatility. In real markets, they do not: the OTM put at the same expiry is more expensive (higher IV) than the OTM call. The Black-Scholes framework cannot explain this difference; it requires a more sophisticated model that incorporates stochastic volatility (where the volatility itself changes over time), jump processes (where the stock can gap suddenly), or local volatility surfaces (where IV is a function of both strike and time to expiry).

For practical options trading, the lesson is that implied volatility from different strikes should not be compared as if they represent the same thing. The "16% IV" on an ATM option and the "22% IV" on a deep OTM put are not alternative estimates of the same underlying volatility; they are the market's pricing for the specific risk at each strike. The OTM put's higher IV reflects the premium the market demands for providing insurance against a sharp decline, which is real and consistent with the observed frequency of large downside moves in equity markets. Trading with an awareness of this distinction, rather than using a single "the IV" estimate for a stock, is one of the markers of more sophisticated options analysis.

Extended FAQ: options skew

Is it always better to sell OTM puts when skew is steep?

Not necessarily. Steep put skew means OTM puts are expensive relative to the model price, but the elevated price exists because the market is assigning a higher probability to large downside moves. If the market is correct and a large decline occurs, the seller of the expensive OTM put will be assigned or forced to buy back the put at a much higher price. The premium collected for selling the expensive put is the compensation for bearing that risk, not a free edge. The structural edge of selling steep put skew depends on the historical relationship between implied volatility and realized volatility in that specific name: if realized volatility has historically been lower than the implied volatility on OTM puts, then the edge is real over time. If the stock regularly produces the large moves that the steep skew is pricing in, the edge disappears.

What does it mean when skew is inverted (calls more expensive than puts)?

Inverted skew (positive skew, or call skew) means the options market is pricing more upside risk than downside risk. This is unusual for equity index options but occurs on individual stocks when speculative call buying is intense. When call skew spikes on an individual stock, it often indicates: heavy retail or speculative call buying driving up the price of OTM calls, anticipation of a short squeeze where the underlying can rally sharply, or a specific upside catalyst (a rumored acquisition premium, a product launch) that is driving institutional call buying. Inverted skew is temporary on most stocks; when the speculative interest fades or the catalyst resolves, skew typically reverts to the more typical put-skew pattern.

Does skew predict market direction?

Skew reflects current positioning and demand, not future outcomes. Steep put skew does not mean the market will fall; it means hedgers are actively buying protection. The relationship between skew and future returns is complex and context-dependent. In some studies, extreme put skew has been a mild contrarian bullish signal (because heavy hedging removes potential sellers and provides support). In other contexts, rapidly steepening skew has preceded further market stress as the smart money prepares for adverse outcomes. Skew is best interpreted as a positioning indicator that complements, rather than replaces, fundamental and technical analysis.

Skew in spread construction: how the IV curve affects spread pricing

Volatility skew directly affects the pricing of vertical spreads and other multi-leg options strategies. Because the two strikes in a vertical spread carry different implied volatilities (due to the skew), the spread is not simply the difference in the two options' prices based on a single volatility assumption. The skew effectively subsidizes one side of the spread and taxes the other.

For a bull put spread (sell an OTM put, buy a further OTM put), both legs are on the put side of the options chain where skew is steepest. The short leg (the closer-to-the-money put) carries a higher IV than the long leg (the further OTM put), which means the short put commands more premium per unit of strike distance than the long put does. This translates to a more favorable credit-to-risk ratio for the bull put spread compared to a bear call spread at symmetric strikes, in a normal steep-put-skew environment. Skew is one of the reasons why put credit spreads (bull put spreads) often collect more premium and have better apparent risk-to-reward than call credit spreads (bear call spreads) at equivalent distances from the current price.

For a bear put spread (buy an OTM put, sell a further OTM put), the reverse is true: the long leg is on the steep-IV side (higher IV) and the short leg is on the flatter part of the curve (lower IV). The spread is more expensive to enter than a symmetric analysis would suggest because the bought option carries a skew premium that inflates its cost. Bear put spreads cost more in steep-skew environments than bear call spreads at equivalent distances, all else being equal.

Understanding this skew impact on spread pricing prevents the common mistake of comparing put spreads and call spreads purely by their dollar credit or debit without recognizing that the IV curve is treating each leg differently. The "better looking" put spread premium in a steep-skew environment does not necessarily mean a better risk-adjusted bet; it reflects the structural premium on put-side IV that exists for fundamental reasons.

Historical skew episodes and what traders learned from them

Skew has behaved distinctively during major market episodes, and each episode provides a concrete lesson about how skew functions as a market signal and a positioning tool.

The 2020 March sell-off and COVID crash was one of the fastest and steepest skew spikes in equity index options history. In the days and weeks before the crash became undeniable, put skew on SPY and SPX was already expanding significantly as institutional hedgers were quietly building put positions. The skew expansion preceded the visible price decline by days, reflecting the early-mover advantage of institutional options traders who were positioning for a large downside scenario before it was consensus knowledge. Options traders monitoring skew levels saw the institutional hedging buildup before the price action confirmed the crash.

The 2021 meme stock episodes produced the opposite pattern in individual stocks. GameStop, AMC, and similar heavily-shorted names developed dramatic call skew in the weeks before the most intense short squeeze phases. OTM calls on these names began trading at IV levels far above their OTM puts, driven by retail traders aggressively buying upside optionality. The positive skew signal in those names was a warning of speculative positioning that eventually drove the stock prices to levels that would have seemed impossible weeks earlier. Traders monitoring skew as a real-time positioning indicator could see the speculative demand building in these names through the call skew expansion before the squeeze accelerated.

The practical lesson from both episodes: skew is not a passive reflection of past volatility; it is an active signal of current positioning. Institutions and sophisticated traders use options to express views and manage risk, and their collective demand for specific strikes shapes the skew curve in ways that are observable in real time. Following skew changes, rather than only following price changes, provides an additional information layer that helps options-aware traders understand what market participants are actually doing, not just what prices are doing.

Using skew as part of a complete options analysis framework

Skew is most valuable when used as one element of a complete options analysis process, not as a standalone signal. The full framework for evaluating any options position combines: the absolute level of implied volatility (is premium expensive or cheap on an absolute basis?), the IV rank relative to recent history (is the current IV elevated or depressed relative to what is typical for this stock?), the skew profile (which direction is the options market positioning, and how intensely?), and the specific options flow signals visible in the tape (are large institutional entities actively buying or selling in ways that confirm the skew reading?).

Each element provides a different piece of the positioning picture. IV level and rank determine whether buying or selling premium is the structurally favorable approach. Skew determines which side of the options chain (calls or puts) is offering the better risk-adjusted opportunity. Flow data from RadarPulse confirms whether the skew reading corresponds to actual large-order activity or is a residual from stale positioning. Together, these four elements produce a richer analysis than any one of them delivers independently. Traders who incorporate skew into this broader framework consistently produce more nuanced position selections than those who rely on price targets and IV levels alone.

This page is educational and does not constitute financial advice. Options trading involves risk of loss.

Frequently asked questions

What is volatility skew in options?

Volatility skew is the pattern where options on the same underlying and expiry carry different implied volatilities at different strikes. In equity markets, OTM puts typically have higher IV than ATM options or OTM calls, reflecting persistent demand for downside protection. The skew reveals which part of the options chain buyers are crowding into.

How do you measure options skew?

The standard method is 25-delta put IV minus 25-delta call IV on the same expiry. Positive values mean put skew; negative values mean call skew. You can also compare a specific OTM put strike IV to the ATM IV. Risk reversals are the traded version of this measure: the net premium of a long call / short put structure reflects how expensive one side is versus the other.

What does steep put skew signal?

Steep put skew means buyers are paying above-average premiums for downside protection. This often reflects institutional hedging, elevated macro uncertainty, or fear of a drawdown. It does not predict a market move, but it shows where the crowd is spending money to protect itself. Skew spikes on individual stocks can be especially telling when they appear ahead of a known catalyst.

Why does skew steepen before earnings?

Before an earnings release, implied volatility rises broadly because the outcome is binary and uncertain. The directional uncertainty often translates into uneven demand across strikes: one side of the chain gets bid more aggressively than the other depending on the sentiment around the name. After the earnings print, IV collapses and skew typically resets toward its normal baseline.

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