The Skew Decoder Ring
- Skew measures how expensive puts are relative to calls at equal distances from the money
- Puts almost always cost more than calls because markets crash faster than they rally
- When skew steepens suddenly, smart money is buying crash insurance — heed the warning
- Extreme skew preceded every major crash — 1987, 2008, 2020
- Flat or inverted skew signals complacency — often right before disaster
- Skew is the VIX's smarter cousin — it tells you not just how much fear, but WHERE the fear is
The Market's Secret Fear Map
October 15, 2014. The S&P 500 fell 5% in a single day — the biggest drop since 2011. Headlines screamed about flash crashes and liquidity crises.
But one group of traders wasn't surprised. They saw it coming weeks earlier — in the skew.
Starting in late September, the put skew on SPX options began steepening dramatically. Out-of-the-money puts, which normally traded at a premium to ATM options, were getting even MORE expensive. Someone was buying massive crash insurance.
The VIX? It was still at 14. Asleep. Showing no fear.
The skew told the truth.
"VIX tells you the market is scared. Skew tells you WHAT the market is scared of. It's the difference between knowing there's a fire somewhere and knowing which building is burning."
— CBOE Volatility Researcher
This is the story of skew — the most powerful and least understood fear indicator in the options market. Once you learn to read it, you'll see things others miss.
What Is Volatility Skew?
In a perfect, textbook world, all options at the same expiration would have the same implied volatility. A 5% out-of-the-money call would have the same IV as a 5% out-of-the-money put.
Reality is messier. And that mess is information.
Volatility skew describes how IV changes across different strike prices. When you plot IV against strikes, you get a curve — the "volatility smile" or "smirk."
The Shape of Fear
OTM puts almost always have higher IV than ATM options, which have higher IV than OTM calls. This creates the classic "smirk" shape. The steeper the left side, the more fear.
Why does this pattern exist?
Three reasons:
1. Markets crash faster than they rally. The S&P 500's worst daily drops are 2-3x larger than its best daily gains. Put buyers need protection against these violent moves, so they pay a premium.
2. Institutional demand for hedges. Every pension fund, endowment, and risk-managed portfolio needs downside protection. This constant demand for puts keeps them expensive.
3. Volatility expands in crashes. When markets fall, realized volatility explodes. Puts become more valuable precisely when you need them most. Sellers demand higher premiums to account for this.
OTM Put IV: 28%
Out-of-the-money puts trade at elevated IV because crashes are violent and volatility expands
ATM IV: 20%
At-the-money options are the benchmark — the "fair" price for volatility
OTM Call IV: 18%
Out-of-the-money calls are cheap because rallies are slow and volatility compresses
The Skew: 10 vol points
The difference between OTM put IV and ATM IV. This number is your fear gauge.
How to Read the Skew: A Practical Guide
The skew isn't just a static picture. It moves. It breathes. And its movements tell you stories about what's happening under the surface.
Flat Skew
What it looks like: Put IV and call IV are similar. The smile is more symmetric.
What it means: Complacency. Nobody is buying crash insurance. Often happens after extended rallies.
Normal Skew
What it looks like: Put IV is 3-5 vol points higher than ATM.
What it means: Healthy skepticism. Normal hedging activity. Markets functioning well.
Steep Skew
What it looks like: Put IV is 8-15 vol points higher than ATM.
What it means: Fear is building. Smart money is buying insurance. Something is brewing.
Extreme Skew
What it looks like: Put IV is 20+ vol points higher than ATM.
What it means: Panic is imminent or happening. Crash protection at any price. Run.
But here's the key insight: it's not the absolute level of skew that matters most — it's the CHANGE in skew.
If skew has been at 5 for months and suddenly jumps to 10, that's a signal. Someone with big money and better information just decided they need protection. Pay attention.
"When skew steepens quickly while the VIX stays flat, that's the most dangerous signal. It means the smart money is hedging quietly while the dumb money sleeps. The disconnect doesn't last long."
— Volatility Hedge Fund Manager
The Evidence: Skew Called Every Major Crash
This isn't theory. Skew has been a leading indicator of market crashes for decades. Here's the evidence:
Black Monday, 1987: In the two weeks before the crash, put skew on S&P options went vertical. OTM puts were trading at 2x the IV of ATM options — unprecedented at the time. The crash followed.
2008 Financial Crisis: Skew on financial sector options started steepening in early 2007 — a full year before Lehman collapsed. By summer 2008, put skew on bank stocks was at levels that implied 30% crash probability. The actual crash was 50%.
COVID Crash, 2020: In January 2020, while the market made new highs, SPX put skew began steepening. By mid-February, it was at the highest levels since 2018. Two weeks later, the market crashed 34%.
The Divergence Signal
When skew rises while prices stay flat or continue higher, that divergence is the signal. Smart money is hedging while the crowd stays bullish. The resolution is always in skew's favor.
2000 Dot-Com
Tech stock skew inverted in late 1999 — calls MORE expensive than puts. Bubble psychology. Crash followed in March 2000.
2007 Housing
Put skew on homebuilder stocks exploded in early 2007. The sector fell 80% over the next two years.
2014 Oil Crash
Skew on energy ETFs steepened 3 months before oil crashed from $100 to $45.
2020 COVID
SPX skew at 10-year highs in January. Market at all-time highs. Crash in March.
Skew vs VIX: Why Skew Is Smarter
Everyone knows the VIX — the "fear index." But VIX has a problem: it only tells you HOW MUCH fear exists, not WHERE the fear is focused.
Skew is more specific. It tells you whether the fear is concentrated in crash scenarios (steep put skew) or melt-up scenarios (steep call skew).
What VIX Tells You
"The market expects 20% annualized volatility over the next 30 days." That's it. No direction. No distribution. Just magnitude.
What Skew Tells You
"The market expects crashes to be more violent than rallies." It shows the SHAPE of expected returns, not just the magnitude.
VIX Can Be Low...
...while skew is high. This happens when the market is complacent about normal volatility but smart money is buying crash insurance.
That's the Danger Zone
Low VIX + High Skew = The most dangerous setup. Complacency on the surface, fear underneath. Crash incoming.
The CBOE actually publishes a "SKEW Index" (ticker: SKEW) that measures this directly. When SKEW is above 130 and VIX is below 15, history shows that crashes follow within weeks.
"VIX is the market's blood pressure. SKEW is its ECG. You can have normal blood pressure and still have a heart attack if the rhythm is wrong. Watch both."
— Tony Cooper, Double-Digit Numerics
Trading Strategies Based on Skew
Now that you can read skew, here's how to profit from it:
When Skew is Steep
Puts are expensive. Sell put spreads (risk-defined) to capture the premium. But be aware: skew is steep for a reason.
When Skew is Flat
Puts are cheap. Buy protective puts. The crash insurance is on sale. Use the complacency to your advantage.
When Skew Diverges from Price
The warning light. Reduce risk exposure. Add hedges. The smart money sees something you don't.
Skew Trades
Trade the skew itself. Risk reversals (long call, short put) profit when skew flattens. The opposite profits when it steepens.
The Risk Reversal Trade:
When skew is extreme (puts way more expensive than calls), you can sell the expensive put and buy the cheap call. This is called a "risk reversal."
Warning: This trade is bullish AND betting that skew normalizes. If the market crashes, you're doubly wrong. Only use when you have conviction that skew is overdone.
"Skew trades are volatility trades in disguise. When you sell steep put skew, you're betting against tail risk. Sometimes that's smart. Sometimes that's how you blow up. Know the difference."
— Benn Eifert, QVR Advisors
The Map to Fear
The volatility skew is the market's fear fingerprint — a DNA sample of what institutional traders are worried about.
While the VIX tells you the temperature, skew tells you where the fever is. It's specific. It's directional. And it has a track record of calling major moves.
The traders who watch skew aren't surprised by crashes. They see the insurance premiums rising. They see the divergences forming. They see smart money quietly hedging while everyone else celebrates new highs.
Now you can see it too.
The question is: when skew starts screaming, will you listen?
Your New Superpower
Check skew before every major trade. Compare it to historical norms. Watch for divergences. The few minutes spent reading the fear map can save you from disasters — and show you opportunities others miss.