Understanding Volatility Skew

In equity markets, "skew" refers to the phenomenon where out-of-the-money (OTM) put options trade at a higher implied volatility (IV) than OTM call options.

Why Does It Exist?

This was not always the case. Before the 1987 crash, skew was relatively flat. After the crash, market participants realized that stocks tend to fall much faster than they rise (seeking downside protection).

Trading Implications

• Vertical Spreads: Selling OTM puts can be attractive due to the higher premium, but carries tail risk.
• Risk Reversals: A strategy involving buying a call and selling a put.

"The skew is fear in numerical form."

Stay tuned for more deep dives into volatility surfaces.