CandleFocus Glossary Editor
Volatility skew is an important concept to understand when it comes to options trading. It describes the phenomenon that not all options on the same underlying and expiration have the same implied volatility assigned to them in the market. In other words, the volatility of certain options differs from the others. What this means is that there is not a uniform structure of implied volatilities around the underlying’s price; instead, there can be a variety of implied volatilities depending on the strike prices available.
Whenever we talk about volatility skew in the context of stock options, we are referring to the general principle that downside strikes (options with strike prices below the current price of the underlying asset) usually have a higher implied volatility than upside strikes (options with strike prices higher than the current price). This also explains why when you look at a volatility chart, it appears to have a smile or curve convex shape, indicating that demand for options is greater when they are in-the-money or out-of-the-money, compared to the at-the-money options.
Volatility skew can have far-reaching effects on the options trading market and understanding it is essential for a successful options trading strategy. The most common way to make use of skew is to buy options with lower implied volatility than at-the-money options and sell options with higher implied volatility. These trades are popularly known as ‘Calendar Spreads’ or ‘Volatility Spreads’.
The good news is that volatility skew characteristically remains meaningful for a surprisingly wide range of underlying assets, meaning that one can apply the principles of skew to the options trading of different asset classes in general. This makes it possible to use volatility skew as an approach to manage options trading portfolios in a consistent fashion.
Overall, volatility skew is a critical concept to understand when it comes to options trading, as it can help to make more informed decisions when choosing between different options. Knowing how the implied volatility of different options can differ depending on the strike price of such options is an effective approach to manage options portfolios, and can be especially helpful in market scenarios that expect significant volatility in the near future.
Whenever we talk about volatility skew in the context of stock options, we are referring to the general principle that downside strikes (options with strike prices below the current price of the underlying asset) usually have a higher implied volatility than upside strikes (options with strike prices higher than the current price). This also explains why when you look at a volatility chart, it appears to have a smile or curve convex shape, indicating that demand for options is greater when they are in-the-money or out-of-the-money, compared to the at-the-money options.
Volatility skew can have far-reaching effects on the options trading market and understanding it is essential for a successful options trading strategy. The most common way to make use of skew is to buy options with lower implied volatility than at-the-money options and sell options with higher implied volatility. These trades are popularly known as ‘Calendar Spreads’ or ‘Volatility Spreads’.
The good news is that volatility skew characteristically remains meaningful for a surprisingly wide range of underlying assets, meaning that one can apply the principles of skew to the options trading of different asset classes in general. This makes it possible to use volatility skew as an approach to manage options trading portfolios in a consistent fashion.
Overall, volatility skew is a critical concept to understand when it comes to options trading, as it can help to make more informed decisions when choosing between different options. Knowing how the implied volatility of different options can differ depending on the strike price of such options is an effective approach to manage options portfolios, and can be especially helpful in market scenarios that expect significant volatility in the near future.