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Understanding an options volatility skew is important in understanding the value and therefore the risk attached to that option for buying or selling it for both hedging or speculation. With that understanding implied volatility (IV).

Options Implied Volatility

Implied Volatility

Implied volatility rises and falls with the uncertainty in markets and the underlying stock increases. IV rises when markets decline; IV falls when markets rally. This IV moves differently for different assets relative to key benchmarks also. An example is stocks in the S&P 500 move differently, which is called the beta to that index.

An option is priced differently for different underlying stocks, event risks and the changes triggered at different options' trading prices and implied volatility (IV). It varies at different strike prices, in-the-money, out-of-the-money, and at-the-money options at the same expiration

The Volatility Smile Became The Volatility Skew or Put Skew

Pre the eye opening market crash of Black Friday 1987 implied volatility for both puts and calls increased as the strike price moves away from the current stock price leading to a "volatility smile" that can be witnessed when charting the options price data. Out-of-the-money (OTM) options (puts and calls) tended to trade at prices that seemed to be too expensive.  When the implied volatility was plotted against the strike price the curve was U-shaped and resembled a smile.

Post the 1987 crash matters changed as investors became more aware. OTM put options have been much more attractive to buyers because of the possibility of a 'black swan'. The increased demand for puts has led to higher implied volatility. As a result, the "volatility smile" has been replaced with the "volatility skew". Strike vs. IV illustrates a volatility skew.

Volatility Skew v Smile

The term "volatility skew" refers to the fact that implied volatility is noticeably higher for OTM options with strike prices below the underlying asset's price. And IV is noticeably lower for OTM options that are struck above the underlying asset price.

Volatility Skews in Major US Indices Options

via @CommodityImpVol

SP Options 8 26 21

Nas Options 8 26 21

Russel Options 8 26 21

Commodities also have different skews depending on event risk, seasonality and other uniqie factors. Here is a look at natural gas heading into the 2021 Hurricane season.

Options Natural Gas

Trade Smart''

Source: CommodityVol TradersCommunity

KnovaWave @Knovawave

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