Volatility Skew

AAA

DEFINITION of 'Volatility Skew'

The difference in implied volatility (IV) between out-of-the-money, at-the-money and in-the-money options. Volatility skew, which is affected by sentiment and the supply/demand relationship, provides information on whether fund managers prefer to write calls or puts.

Also known as "vertical skew".

Volatility Skew

BREAKING DOWN 'Volatility Skew'

A situation where at-the-money options have lower IVs than out-of-the-money options is sometimes referred to as a volatility "smile", due to the shape it creates on a chart (as above). In markets such as the equity markets, a skew occurs because money managers usually prefer to write calls over puts.

RELATED TERMS
  1. Implied Volatility - IV

    The estimated volatility of a security's price.
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Volatility Smile

    A u-shaped pattern that develops when an option’s implied volatility ...
  4. Call

    1. The period of time between the opening and closing of some ...
  5. Option

    A financial derivative that represents a contract sold by one ...
  6. In The Money

    1. For a call option, when the option's strike price is below ...
Related Articles
  1. Options & Futures

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  2. Options & Futures

    Options Basics Tutorial

    Discover the world of options, from primary concepts to how options work and why you might use them.
  3. Options & Futures

    Out-Of-The-Money Put Time Spreads

    Learn about this low-risk, bearish options strategy used to speculate on major market declines.
  4. Options & Futures

    Ratio Writing: A High-Volatility Options Strategy

    Selling a greater number of options than you buy profits from a decline back to average levels of implied volatility.
  5. Options & Futures

    Forecasting Market Direction With Put/Call Ratios

    Options are not only trading instruments but also predictive tools that can help us gauge the feelings of traders.
  6. Options & Futures

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
  7. Options & Futures

    Do Option Sellers Have a Trading Edge?

    Take a look at a study that discovered that three out of every four options expired worthless.
  8. Options & Futures

    The ABCs Of Option Volatility

    The mystery of options pricing can often be explained by a look at implied volatility (IV).
  9. Fundamental Analysis

    Examining Mexico's Trillion-Dollar GDP

    Examining the gross domestic product growth and composition of Mexico, the second largest economy in Latin America
  10. Fundamental Analysis

    What Causes Inflation in the United States

    Inflation is the main catalyst behind U.S monetary policy. But what causes this phenomenon of sustained rising prices? Read on to find out.
RELATED FAQS
  1. What is the relationship between implied volatility and the volatility skew?

    The volatility skew refers to the shape of implied volatilities for options graphed across the range of strike prices for ... Read Full Answer >>
  2. How is implied volatility used in the Black-Scholes formula?

    Implied volatility is derived from the Black-Scholes formula and is an important element for how the value of options are ... Read Full Answer >>
  3. How can I find out which stocks also trade as options?

    The trading of options has become increasingly popular among retail investors as they become aware of the many different ... Read Full Answer >>
  4. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What are the main risks associated with trading derivatives?

    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Recession

    A significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, ...
  2. Bubble Theory

    A school of thought that believes that the prices of assets can temporarily rise far above their true values and that these ...
  3. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  4. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  5. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  6. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!