Pull up any options chain on SPY. Find a put and a call that are the same distance from the current price — say, both $10 out of the money. Now compare their premiums. The put costs more. Sometimes significantly more.
This isn’t a bug. It’s not a market inefficiency waiting to be arbitraged away. It’s one of the most persistent features of options markets, and it has a name: volatility skew.
Understanding skew won’t just make you a better options trader — it will change how you think about risk, fear, and where the real edge lives in an options chain.
The Observation: Puts Are Expensive
Implied volatility (IV) is the market’s estimate of how much a stock will move. Higher IV means the market expects bigger moves, and higher IV means higher option premiums. If IV were flat across all strikes, a put and a call at the same distance from the current price would cost about the same.
But IV is not flat across strikes. It’s skewed.
In almost every equity and index product, out-of-the-money (OTM) puts carry higher implied volatility than OTM calls at the same distance from the at-the-money (ATM) strike. The further you go out of the money on the put side, the higher the IV climbs. On the call side, IV tends to drop or stay flat.
If you plot IV on the y-axis and strike price on the x-axis, you don’t get a flat line. You get a curve that tilts downward to the right — steeper on the put side, flatter on the call side. Traders call this the volatility smile or volatility smirk, depending on how pronounced it is. In equities, it’s almost always a smirk: heavy on the left (puts), light on the right (calls).
Why Does Skew Exist?
Skew isn’t random. It’s the market pricing in three realities about how stocks actually move.
1. Institutional Demand for Downside Protection
Pension funds, endowments, and large asset managers hold billions of dollars in equities. They need downside protection. Buying OTM puts is the simplest way to hedge a portfolio against a crash. This isn’t optional for many of these institutions — their mandates require it.
That creates persistent, structural demand for OTM puts. And when demand for a product is constant and inelastic, the price stays elevated. Market makers know this demand is coming every month, every quarter, every year. They price it in.
2. Markets Fall Faster Than They Rise
Bull markets grind. Bear markets crash. This asymmetry is real and measurable. The S&P 500 took two years to rally 50% off the 2020 COVID lows, but it only took five weeks to drop 34% on the way down. Drawdowns are sudden, violent, and correlated — everything sells at once.
Options pricing reflects this. The probability of a large downside move is higher than the probability of an equally large upside move. OTM puts should be more expensive because the scenarios they protect against — crashes, gaps down, panic — are more likely and more severe than equivalent upside moves.
3. Post-1987: A Permanent Shift
Before October 19, 1987, volatility skew was minimal. Options were priced roughly in line with the Black-Scholes model, which assumes symmetric, normally distributed returns. Then the S&P 500 dropped 22.6% in a single day. The Black-Scholes model said this was essentially impossible — a 20+ standard deviation event.
After Black Monday, the options market permanently repriced tail risk. Volatility skew appeared overnight and has never gone away. It’s been a feature of options markets for almost four decades. It’s not going anywhere.
Reading Skew as a Sentiment Indicator
Skew isn’t static. It compresses and expands as market sentiment shifts. Learning to read the shape of the skew curve gives you a real-time window into how much fear or complacency is priced into the market.
Steep Skew = Fear
When the skew curve is steep — OTM puts carry much higher IV than ATM options — the market is pricing in significant downside risk. Institutions are aggressively buying protection. This often appears ahead of known risk events (elections, FOMC, earnings), during selloffs, or when the VIX term structure is inverted. Translation: The market is scared. Downside protection is in demand.
Flat Skew = Calm
When the skew curve flattens — IV is more uniform across strikes — the market is relaxed. Institutions aren’t panicking for protection. Put demand is normal. This typically shows up during steady uptrends, low-VIX environments, and when markets have been grinding higher for weeks without a pullback. Translation: The market is comfortable. No urgency to hedge.
Reverse Skew = Rare Euphoria
In extremely rare situations, OTM calls can carry higher IV than OTM puts. This reverse skew typically appears in meme stocks, speculative blow-off tops, or individual names where call buying has become frenzied. It’s almost never seen in broad indices. Translation: The crowd is euphoric. Speculative call demand is overwhelming hedging demand. Be cautious.
Skew Shift = Watch Closely
The change in skew matters as much as the level. If skew is steepening rapidly, institutions are rushing to buy protection — even if the stock hasn’t sold off yet. If skew is flattening after a selloff, the market is starting to believe the worst is over. Translation: Track the direction of skew, not just the snapshot.
Practical Example: SPY Skew in Action
Now here’s where it gets interesting for your trading.
Trading Implications: How to Use Skew
Skew exists for a reason — tail risk is real, and the people buying those puts aren’t fools. But understanding skew gives you a framework for making smarter trades on the options chain.
1. Put Credit Spreads: Selling What’s Expensive
Because OTM puts carry inflated IV, selling OTM put spreads lets you collect premium that’s juiced by the skew. You’re selling the expensive product and buying the cheap one.
2. Risk Reversals: Exploiting the Asymmetry
A risk reversal involves selling an OTM put and using the premium to buy an OTM call (or vice versa). Because skew makes puts expensive and calls cheap, a bullish risk reversal (sell the put, buy the call) often costs less than you’d expect — or can even be done for a credit.
You’re essentially using the market’s fear premium to fund your bullish bet. This works best when you have a directional view and the skew is steep.
3. Don’t Buy Puts When Skew Is Extreme
This is the flip side. If skew is already steep and you’re buying OTM puts for protection, you’re paying the maximum fear premium. You’re buying insurance during the hurricane. Every other institution already had the same idea, and their demand is what made those puts expensive in the first place.
That doesn’t mean you should never buy puts. Sometimes you need protection regardless of price. But you should know what you’re paying for. When skew is extreme:
Skew Across Products: It’s Not Just SPY
Volatility skew shows up everywhere, but its shape varies by product:
| Product | Skew Behavior | Why |
|---|---|---|
| S&P 500 / SPY | Steep, persistent skew | Massive institutional hedging demand. This is the most liquid options market in the world, and skew is a defining feature. |
| Large-cap tech | Moderate skew | Hedging demand exists but is less concentrated than in index products. Skew steepens ahead of earnings. |
| Small-cap / biotech | More symmetric or even reverse | Speculative call buying can be extreme. In some meme stocks, calls are more expensive than puts — reverse skew. |
| Commodities | Varies by product | Crude oil can have reverse skew (upside supply shocks). Gold tends toward classic put skew. Each commodity has its own risk profile. |
Connecting Skew to GEX
If you’re already using GEX analysis on AlphaTrak, volatility skew adds another dimension. They complement each other:
Skew Tells You Price
Skew tells you which strikes are expensive and which are cheap. It’s about the cost of options at different strikes — where the market is overpricing or underpricing risk.
GEX Tells You Flow
GEX tells you which strikes have gamma that will drive dealer hedging flows. It’s about the mechanical impact of options positioning on the stock price.
Together, they give you the full picture. Skew tells you where the fear is priced. GEX tells you where dealers will act on it. A strike with steep skew and heavy gamma is a strike the market cares about deeply — both in terms of what people are willing to pay and the hedging activity it will trigger.
Common Mistakes with Skew
Skew is straightforward in concept but easy to misapply. Avoid these traps:
- Assuming skew is mispriced. Skew exists because tail risk is real. The 2008 crash, the 2020 COVID crash, the 2022 bear market — these weren’t anomalies. They’re the exact scenarios OTM puts are designed for. Selling naked puts “because skew makes them expensive” without understanding the risk is how accounts blow up.
- Ignoring skew changes. Static skew is just a snapshot. What matters is whether skew is steepening or flattening. Rapidly steepening skew ahead of an event is an early warning. Flattening skew after a selloff suggests the worst may be priced in.
- Trading skew without direction. Skew informs your structure (which spread to use, which strikes to pick), not your direction. You still need a directional thesis from your chart work, moving averages, and GEX levels. Skew tells you how to express that thesis efficiently.
- Confusing skew with overall IV level. Skew is the shape of the IV curve across strikes. Overall IV level (like VIX) is the height of the curve. You can have steep skew in a low-VIX environment (people hedging in calm markets) or flat skew in a high-VIX environment (panic is uniform across strikes). They’re different signals.
The Bottom Line
Volatility skew is the market telling you something fundamental: downside risk is more expensive to insure against than upside potential. This isn’t irrational. Markets crash faster than they rally. Institutions need protection. And every options trader alive remembers (or has studied) what happens when the tail event arrives.
Your job isn’t to fight the skew. It’s to use it.