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Implied volatility skew explained

What IV skew across strikes shows, why downside puts usually carry higher implied volatility, and what skew does not tell you.

Reviewed · Sources at the end · How Vyreon measures
Vyreon's per-security reports are not live yet; this page describes what they will measure. Examples are illustrative.

Implied volatility skew is how implied volatility changes across strike prices for the same expiry. In US stock index options since the 1987 crash, downside puts have carried higher implied volatility than upside calls, which means protection against a fall is priced richer. Options on individual stocks have shown a less pronounced version of the same pattern.

What IV Skew Measures

If every strike had the same implied volatility, the skew would be flat. In equity options, strikes further below the current price have generally carried higher implied volatility (see Sources). Explanations studied in the research include demand for downside protection and the tendency of volatility to rise when prices fall.

Skew can be summarized as a slope: how much implied volatility rises or falls per unit of distance from the current price.

How To Read It

  • A steeper negative put slope means downside protection is priced more richly relative to at-the-money options.
  • A flatter slope means the market is pricing downside and upside moves more evenly.
  • Changes in skew over time can show a shift in how options are priced, even when the at-the-money implied volatility barely moves.

What Skew Does Not Tell You

  • Skew is not a directional prediction. A steep skew does not mean a fall is coming. It means protection costs more.
  • Skew measures from different providers may not be comparable. Some use a 25-delta spread, others a slope across strikes. Always check the definition.

How Vyreon Measures It

Vyreon measures skew as a robust slope (Theil–Sen) of the data provider's implied volatility across strikes for the standard monthly expiry at least 14 days out. Calls are fitted on their at-the-money and upside strikes, puts on their at-the-money and downside strikes, so deep in-the-money options with unreliable implied volatility do not distort the slope. It is a slope across strikes, not a 25-delta skew.

Related: implied volatility · IV term structure

Sources

  • Mark Rubinstein, "Implied Binomial Trees", Journal of Finance (1994): implied volatility varying with strike in S&P 500 index options after the 1987 crash.
  • Gurdip Bakshi, Nikunj Kapadia and Dilip Madan, "Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options", Review of Financial Studies (2003): individual stocks' option-implied distributions are far less negatively skewed than the index's.
  • Nicolas P. B. Bollen and Robert E. Whaley, "Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?", Journal of Finance (2004): demand for options and the shape of the skew.
  • Andrew A. Christie, "The Stochastic Behavior of Common Stock Variances: Value, Leverage and Interest Rate Effects", Journal of Financial Economics (1982): volatility rising as stock prices fall.
  • Henri Theil, "A Rank-Invariant Method of Linear and Polynomial Regression Analysis" (1950), and Pranab K. Sen, "Estimates of the Regression Coefficient Based on Kendall's Tau", Journal of the American Statistical Association (1968): the Theil–Sen slope.