Volatility Skew

Volatility skew describes how the market's expectation of future price swings, as reflected in options prices, differs depending on which strike price you look at. In theory, if a stock could move up or down with equal ease, options that are the same distance from the current price — say, a call struck 10% above and a put struck 10% below — would carry the same "implied volatility," a number derived from the option's price that represents how much movement the market is pricing in. In practice they rarely match, and the gap between them is the skew.

The most common pattern, especially in individual stocks and stock indexes, is that downside puts carry higher implied volatility than equivalent upside calls. This reflects fear: investors are more willing to pay up for insurance against a crash than for a shot at an equally sized rally, so demand pushes put prices, and their implied volatility, higher. This shape is sometimes called a "volatility smirk" because if you plot implied volatility across strikes it slopes rather than sitting flat.

Skew is measured by comparing implied volatility across strikes at the same expiration date, holding the distance from the current price constant. A steep skew means the market is pricing a much bigger risk of a sharp drop than of a sharp rise; a flat skew means calls and puts are priced similarly. Skew can also shift shape entirely — commodities sometimes show the opposite pattern, with upside calls more expensive, because a supply shock tends to spike prices higher rather than lower.

The nuance that trips people up is that skew is not the same thing as implied volatility itself. A stock can have a low overall implied volatility level but a very steep skew, or a high implied volatility level with almost no skew. Skew is about the relative pricing across strikes, not the absolute level of expected movement.