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Volatility skew

The tendency for downside strikes to trade at higher implied volatility than upside strikes in equities, reflecting crash risk and hedging demand.

The volatility smile across strikesImplied volatility plotted against strike, dipping near the money and turning up at both ends, more steeply on the downside.Implied volatility32%28%24%20%8090110120Puts below the money cost moreFar calls cost more tooLowest IV near the moneyATM 100Strike price
The volatility smile. Options on the same stock and the same expiry are not priced off one volatility. Strikes near the money carry the lowest implied volatility, and it rises towards both ends — usually faster on the downside, which tilts the smile into a skew.

Before 1987 equity options were priced with a roughly flat smile. After it, the market permanently repriced downside tails, and today every equity chain shows puts richer than equidistant calls. The skew is both a memory of gap risk and a supply-and-demand artefact: everyone wants protection and few want to sell it.

Skew changes how every structure prices. It makes put spreads cheaper to sell and more expensive to buy, it makes zero-cost-collars asymmetric, and it means delta-as-probability overstates the true chance of a large fall. Trading against the skew is trading against a persistent, well-paid insurance market.

Example: XYZ at $50 with 45 days to expiry. The $45 put implies 41% volatility while the $55 call implies 29%. Same distance from the money, twelve points apart. That gap is why the $45 put costs $0.90 while the $55 call costs $0.55.

Related: volatility-smile, volatility-surface, risk-reversal, skew-index

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