How to use the SKEW Model Lesson

In this lesson, you’ll learn how to leverage the SKEW Model alongside term structure charts to identify where options are relatively cheap or expensive—a critical skill for making smarter trading decisions. We’ve introduced new tools including a term structure chart that displays current data versus yesterday, five days ago, and 30 days ago, giving you insight into market shifts like contango and backwardation.

The term structure reveals how implied volatility changes across different expiration dates. When markets experience low realized volatility but market makers expect potential spikes, you’ll see an upward sloping term structure (contango). For example, the recent term structure showed low short-term implied volatilities rising over time, signaling that if you’re buying options, shorter-dated options are typically cheaper, while longer-dated options command higher prices for sellers.

The SKEW Model helps you understand relative pricing between puts and calls at different strike prices. Using Nvidia as an example, when put skew reaches the top of its range, puts become relatively expensive compared to calls. If you’re bullish, this creates opportunities to sell expensive puts for income or combine selling puts with buying calls for leveraged exposure. For bearish traders, you can buy in-the-money puts and sell out-of-the-money puts to create a put spread that benefits from the skew.

Even if you’re purely a technical trader not focused on options, the SKEW Model provides valuable signals. When Nvidia’s put skew elevated, it suggested the market was pricing more symmetrical risk rather than explosive upside moves. This insight can help you adjust take profit targets, tightening them when skew indicates increased downside probability rather than expecting continued rallies.

Video Chapters

00:00 – Introduction to term structure charts and past comparisons
00:32 – How term structure and skew identify cheap vs expensive options
02:46 – Combining term structure with the three-month skew model
03:12 – Nvidia skew example and bullish trading strategies
04:27 – Advanced bearish strategies using put spreads
05:34 – Using skew signals for technical trading and profit targets

Key Takeaways

The term structure chart shows implied volatility across expirations, helping identify contango patterns where short-dated options are cheaper
The SKEW Model reveals when puts or calls are relatively expensive, enabling strategies like selling expensive puts or creating favorable put spreads
Elevated put skew signals increased downside pricing, suggesting tighter take profit targets even for non-options traders
Combining both tools gives you a complete view of the volatility surface to find optimal entry and exit points

Video Transcription

[00:00:00.12] - Speaker 1
So first we have a simple, before.

[00:00:02.10] - Speaker 2
We go into that, also one thing that we are introducing that is new is the term structure. So we've added a new chart and we also added past term structure. So you can see the term structure today versus yesterday, five days ago and 30 days ago. So that can give you like a good understanding if the market is changing. You know, the term structure is shifting, moving towards contango, backwardation and so on. And how can that be leveraged? So yeah, yeah.

[00:00:32.09] - Speaker 1
And so really those two things combined, term structure plus skew, it really helps us think about where options are relatively cheap and rich. As traders, we always try to have this idea of, you know, what's fair value and then what's relatively cheap, what's relatively expensive right now, particularly when you're a market maker. And so together that gives the Skew and the term structure give you the whole sense of, hey, if I want to buy options, I want to go find where I think the relatively cheapest place to buy options is in the, you know, in the volatility surface using both term structure and skew. You know, I want to sell options, you know, vice versa. Then I want to find the most expensive implied volatility to sell. So right now, looking at term structure, we can see a pretty consistent stock story over the last day or so. You know, things have kind of become more middling. You know, there's not a strong signal from this. But I'm going to just focus on actually where we were about a day ago, the red line, the red dotted line down there. So, you know, when markets, when markets have periods of really low realized volatility, but market makers, you know, don't want to basically sell, sell longer dated options too cheap because they're concerned about a big spike.

[00:01:55.18] - Speaker 1
We start to see what we saw in the last couple days, which was this big, sometimes called contango, but an upward sloping term structure. So you could see that and we saw that across the board we were seeing these kind of really low short term implied volatilities that were going up over time. So again, the market's telling us that, hey, volatility is really low right now, but it's not gonna, not necessarily gonna stay that way. And as we go further out on the expiration timeline, then we're going to start to see implied volatility go, go up. And so again, if we're, if we're thinking about buying options, you know, typically we're going to get options much cheaper if we buy the very short dated stuff. And if we want to, you know, get higher prices for the options we sell, we're going to want long dated.

[00:02:46.15] - Speaker 2
I think now, Ryan, if you know, like how can we combine and you know, we're just going to do with this one last example, but then we also have a session on July 24th just to specifically talk about skews. But here you see obviously two charts which is the at the money term structure and the Skew 3 months Skew for Nvidia. So how can you actually use this chart and what can you derive from it?

[00:03:12.14] - Speaker 1
Yeah, absolutely. So, so taking a look at Nvidia. So what can we see here? So when we look at the Skew, what we can see is that after a brief dip, the puts have gotten really expensive on Nvidia over the, you know, over the time period that's in question or at least relatively expensive compared to they're, they're at the top end of the range. So, you know, not a great time to be buying puts as a trader. So there's a few different strategies that we can look at here. So kind of beginning level bull strategy. And again, you know, I want to emphasize that these markets don't necessarily tell you that there's one trade, but depending on what your basic outlook is on the market, you can almost always find an option structure from the Skew that'll support your position. So for example, if you're bullish Nvidia, what, what can you do with this? Well, when you know, puts are relatively high, it might be a good time to actually sell puts to get exposure to Nvidia. You get a long, you know, effectively a long bias by selling those, those relatively expensive puts. And you could also sell the puts and buy the calls, you know, if you wanted to get some leverage.

[00:04:27.22] - Speaker 1
So you might be able to get cheaper leverage if you wanted to do, you know, basically get more exposure to Nvidia than you would otherwise by selling puts and buying calls. And you could probably do that more basically more times than you'd feel comfortable buying underlying contracts. Plus that would help insulate you from some of the noise and the short term choppiness if you just want it to be exposed for the big moves. But let's say you're bearish. This is a little bit more advanced strategy, but knowing that the put skew is the way it is. So those out of the money puts are going to be much more expensive and the calls are going to be relatively cheaper. We could look at buying it in the money put which will actually use the. This is A bit, bit more advanced, but uses the implied volatility from the calls because it's in the money and we can look at buying it in the money put and selling it out of the money put. And so basically creating a put spread. But a put spread that's favorable to us because the put that we're selling is, is going to be higher implied volatility.

[00:05:34.05] - Speaker 1
So we'll collect relative, relatively more premium. We will have to pay a premium to buy this put spread. But it should be relatively cheap to express a fairest view on Nvidia and probably a lot safer than say shorting the stock. What if you're just a technical trader and you're not here to trade options at all? What can we say from this? You know, I think, I think you can actually get a lot out of these Skews, which is why I'm guessing this is such a popular request. You know, if, if I'm trading Nvidia right now and I was long, I would personally be lowering my kind of take profit targets. And the reason being is that the market does not seem to be pricing in the, the risk of the, of a huge spike, you know, a hugely volatile spike. I know that's been happening for an Nvidia for, you know, a while now, but it seems like the market's starting to say that the risk is becoming a bit more symmetrical. So after previously being a stock where the kind of explosive movement was to the upside, it seems that now the market's saying, well, you know, it could be pretty explosive up or down now, you know, suggesting Nvidia has become at least a bit more fairly priced.

[00:06:44.15] - Speaker 1
So if I was, if I was, you know, long Nvidia and working some take profit targets, I would probably tighten those up. I wouldn't be quite as aggressive or ambitious thinking oh, you know, this thing's going to go to the moon. I'd be, I'd be in and out quicker because you gotta, you gotta increase the, the kind of probability of a downside sell off relative to the rally.