Volatility skew
If options were priced by one volatility, every strike of an expiry would show the same IV. They do not. Out-of-the-money puts nearly always carry a higher IV than out-of-the-money calls the same distance away, and the size of that gap, the skew, says how much the market is paying for protection.
The smile and the skew
Plot an expiry's implied volatility against its strikes and you get a curve. For stocks and indices it usually slopes down from left to right: low strikes, the puts that protect against a fall, carry high IVs, and high strikes lower ones. This is the skew. Its shape reflects how stocks behave, falling faster than they rise, and the steady demand for puts as insurance.
Measuring it: the 25-delta skew
To follow the skew from day to day it needs to be one number. The usual one compares two options equally far from the money, measured by delta rather than by dollars, so that the measure means the same for a $20 stock and a $500 one:
25-delta skew = IV of the 25-delta put − IV of the 25-delta call
A 25-delta put is out of the money with roughly a one-in-four chance of finishing in the money, and so is a 25-delta call. If the put trades at 34% and the call at 27%, the skew is 7 points. Options Meerkat reads it at a 30-day maturity, interpolated between the expiries either side, like its ATM IV.
Reading it
- Skew rising (steepening): puts are getting dearer relative to calls. The market is paying up for protection, often before or during a sell-off.
- Skew falling (flattening): the gap narrows. Fear is easing, or calls are in demand, as in a strong rally or a speculative run.
- Skew below zero: calls carry the higher IV. It is rare for an index and happens in single stocks when the market prices a sharp move up, around a takeover or a squeeze.
As with IV itself, a level means more against the stock's own past than against another stock's: some names always carry a steep skew.
Skew and strategies
The skew sets the price of spreads. A steep skew makes put spreads cheaper to buy than their distance suggests and put credit spreads pay more; it makes risk reversals (selling a put to buy a call) pay a credit. Knowing the skew tells you which side of a trade the market is charging for.
In Options Meerkat
The dashboard's skew column is each symbol's 30-day 25-delta skew, and an alert rule can fire when it moves more than a set amount between rounds. The detail page draws the whole curve, the smile, for any expiry, the surface across expiries, and the skew's history under the IV's (h), so you can see whether today's reading is usual for the stock.