Lesson 2: Skew (Strike Structure)

Promise: Understand why OTM puts cost more than OTM calls, and what changes in skew tell you about market fear.

What is Skew?

Skew describes how implied volatility changes as you move across strikes at a fixed point in time.

Think of it like this: Pick one expiry (say, 30 days out). Look at all the options at that expiry - from deep OTM puts to deep OTM calls. Each one has its own IV. If you plot IV against strike, you get a curve. That curve is the skew.

Taking a Snapshot

All options at 30-day expiry

= Skew Curve

This downward slope from OTM puts to OTM calls is called put skew. It's the most common shape.

💡

Skew is the market's price for crash insurance. OTM puts are expensive because everyone wants them.

Why Does Skew Exist?

If the Black-Scholes model were perfect, all strikes would have the same IV. Skew exists because reality is messier.

Black-Scholes makes several assumptions that don't hold in reality:

1. Constant volatility across strikes The model assumes a single volatility number for all options. But the market knows that deep OTM puts face different risk than OTM calls, so they price them differently. This creates skew.

2. You know future volatility in advance You don't. The IV that makes Black-Scholes match the market price is just what traders are willing to pay for that option. Different strikes command different prices based on perceived risk.

3. Log-normal returns (no fat tails) Real markets have "fat tails" - extreme moves happen more often than a normal distribution predicts. This makes crash protection (puts) more valuable.

Black-Scholes Assumption vs Reality

BS: Normal distribution

Reality: Fat tails + left skew

Reality is messier:

• Fat tails: Extreme moves (±3σ+) happen much more often than BS predicts
• Left skew: Crashes are more common than equivalent rallies
• This is why: OTM puts are expensive (crash insurance) and skew exists

4. Continuous hedging is impossible Markets gap. During crashes, you can't hedge smoothly. This gap risk makes downside protection valuable.

5. No jumps Markets can jump instantly (think crypto flash crashes). This tail risk is priced into OTM options.

Bottom line: Black-Scholes is a useful framework, but the market corrects for its limitations by pricing different strikes differently. That correction is skew.

1. Crash Fear (Demand for Protection)

Markets crash more often than they moon. The 2020 COVID drop, the 2022 LUNA/FTX collapses: big down moves happen fast. Traders pay premium for OTM puts as portfolio insurance.

2. Supply/Demand Imbalance

• OTM puts: High demand from hedgers, limited natural sellers
• OTM calls: Less urgent demand, more speculative sellers

3. Realized Asymmetry

Historically, large moves skew negative. This isn't irrational: crashes cluster, rallies grind.

Strike Region

Typical IV

Why

Deep OTM Puts (80% of spot)

Highest

Crash insurance premium

Slight OTM Puts (95%)

High

Common hedge target

ATM (100%)

Baseline

Reference point

Slight OTM Calls (105%)

Lower

Less urgent demand

Deep OTM Calls (120%)

Variable

Can spike on speculative demand

See It In Action

Drag the slider to explore different skew shapes:

Skew Visualization

25d Risk Reversal: +20.0%

Skew Strength: Put Skew

Call SkewFlatPut Skew

Drag the slider to see how skew changes the IV curve across strikes. Put skew (positive RR) is normal; call skew is rare.

Measuring Skew

Traders use standardized metrics to compare skew across time and assets.

Risk Reversal (25-delta)

The most common measure. It compares 25-delta put IV to 25-delta call IV:

25-Delta Risk Reversal

25Δ Put IV

65%

−

25Δ Call IV

53%

=

Risk Reversal

+12%

Interpretation

Elevated put skew - nervous market

OTM puts are 12 vol points more expensive than OTM calls.
The market is paying up for downside protection.

💡

A 25-delta risk reversal of +8% means OTM puts trade 8 vol points higher than equivalent OTM calls. The market is worried about downside.

What Are "Wings"?

Before we talk about wing spreads, you need to know what "wings" are. The wings are the OTM (out-of-the-money) regions on either side of ATM:

Understanding "Wings"

Hover over a region to learn more. When traders say "wings are elevated," they mean both OTM puts AND OTM calls have higher IV than ATM.

ATM-Wing Spread

Now that you understand wings, you can measure how much extra you're paying for those OTM options compared to ATM:

ATM-Wing Spread (Put Wing)

65%

25Δ Put

+13

52%

ATM

25Δ Put IV: 65%

ATM IV: 52%

Put Wing Spread

+13%

Steep wings - elevated fear

The 25Δ put trades 13 vol points above ATM. There is significant premium for downside protection.

Reading Skew Changes

Skew isn't static. It responds to market conditions:

Skew Movement

What It Signals

Typical Cause

Skew steepens

Increasing fear

Market drops, hedging demand spikes

Skew flattens

Decreasing fear

Rally, complacency, put selling

Call skew emerges

Upside FOMO

Parabolic rally, call buying frenzy

Example: BTC Skew During Crashes

During major selloffs (March 2020, May 2021, Nov 2022), BTC put skew spiked dramatically. 25-delta puts traded 20-30 vol points above ATM. After the panic subsided, skew normalized over weeks.

The pattern:

1. Market drops sharply
2. Everyone rushes to buy puts (hedging)
3. Put IV spikes relative to call IV
4. Skew steepens
5. After the dust settles, skew slowly normalizes

Skew in Crypto vs TradFi

Crypto skew behaves differently from equities:

Aspect	Equity (SPX)	Crypto (BTC)
Base skew	Strong and persistent	Variable, sometimes flat
Crash response	Skew explodes	Skew explodes even more
Call skew	Rare	Happens in bull runs
Mean reversion	Slow	Faster

Crypto markets are younger, more speculative, and have different participant mix. Skew can flip from put-heavy to call-heavy within weeks during regime changes.

Trading Implications

If You're Long Options

• Buying OTM puts is expensive due to skew - you're paying for crash insurance
• Buying OTM calls may be relatively cheap
• Skew affects your breakeven: the move needs to be bigger than what's priced in

If You're Short Options

• Selling OTM puts collects skew premium (the insurance fee)
• But you're short crash insurance: the risk is real
• Selling OTM calls may offer less premium but less tail risk

Risk Reversals as a Trade

Some traders trade skew directly: buy the cheap side, sell the expensive side. This is a bet on skew normalizing.

Example: If put skew is extreme (25d RR = +20%), you might:

• Sell expensive 25d puts
• Buy cheap 25d calls
• Net theta positive, betting that fear subsides and skew flattens

This is advanced and has significant risk if the crash actually happens.

Common Mistakes

Mistake	Correction
Ignoring skew when buying puts	You're paying extra for crash protection. Know how much.
Assuming skew is constant	Skew moves with the market. What's steep today may flatten.
Treating all OTM options equally	OTM puts and OTM calls have very different IV and dynamics.
Not understanding why skew exists	Without understanding the "why," you can't predict changes.

SVI (Stochastic Volatility Inspired) Formula

w(k) = a + b × ( ρ(k - m) + √((k - m)² + σ²) )

Hover to explore:

Hover over a variable above to see its meaning.

Key Insight

The ρ parameter is what creates skew. In crypto/equity markets, ρ is typically negative (-0.3 to -0.8), which makes OTM puts more expensive than OTM calls.

Test your understanding before moving on.

Q: Why do OTM puts typically have higher IV than OTM calls?

Q: What does a 25-delta risk reversal of +10% mean?

Q: What typically happens to skew during a market crash?

💡 Tip: Try answering each question yourself before revealing the answer.

See Also

• Skew Reference - Deep dive with more metrics
• Lesson 5: Smile & Smirk - The different shapes skew can take

Navigation: ← Lesson 1: Why Read Volatility | Lesson 3: Term Structure →