FOMO and Skew Breakdown

What Do We Mean By “Skew”?

In options terms, skew measures the difference in implied volatility between out-of-the-money (OTM) puts and calls. One common way to quantify it is:

Skew = (25-delta Put IV – 25-delta Call IV) / ATM IV

In simple terms, it tells you how much more (or less) traders are paying for downside protection versus upside speculation. When investors fear a big selloff, they tend to buy puts, pushing up put IV relative to calls — so skew rises. When the market gets comfortable — or even greedy — skew can collapse as traders chase upside exposure instead.

However, there’s a nuance: the “25-delta” reference is floating. The strike that is 25-delta OTM changes as spot moves. This is critical because as the market rallies, the distance between spot and those strikes shifts, dragging the entire skew surface with it.

Why Did 1M Skew Collapse?

First, the recent collapse in near-term skew — now trading around the 30th percentile — wasn’t a sudden, surprising event. It was baked into the positioning months ago. Traders who pay close attention to customer flows, open interest, and dealer inventories could see this coming.

Here’s what happened:

1. Positions Were There Already:
   
   Many institutional players were long puts — classic downside hedges — but also long calls further up the curve. This created a “pinch point” for dealers. As spot moved higher, the puts lost value, so the need for put protection dropped. Meanwhile, the market moved toward the levels where customers held long calls. This forced dealers, who had sold those calls, to hedge by buying the underlying or related futures.
   
2. Risk Reversal Hedging Kicks In:
   
   Dealers are constantly managing their delta and gamma exposure. In this environment, the market’s steady climb turned them into net buyers. But it also shifted their skew risk: they became long risk reversals (long calls vs. short puts). As spot rallied, the dealers had to “lower” their risk reversal exposure: they adjusted their books by reducing the weight on puts (lower IV) and increasing the weight on calls (higher IV).
   
3. Result — Skew Compresses:
   
   This mechanical hedging flow flattens skew. The near-term skew, particularly sensitive to gamma hedging, dropped sharply, while longer-dated skew (like the 3-month) stayed elevated — hence why 1M skew has sunk while 3M skew remained high.
   

Spot-Volatility Correlation: Why It Matters

Many traders get this wrong: they think rising markets must always mean falling volatility. That’s partly true for ATM vol — but skew behavior can diverge. The relationship between spot moves and volatility levels depends on how the underlying options are positioned:

• If the market rallies into an area with heavy long call positions, dealers are forced to buy underlying futures to hedge — reinforcing the rally.
  
• At the same time, their need for downside protection fades, which reduces put IV, flattening the skew.
  
• This is what turns a FOMO-driven rally into a skew compression event.
  

When you understand the mechanics of this positioning, you see why spot-volatile correlations can flip: in this case, higher spot pulled near-term implied vol lower through skew, not necessarily the entire volatility surface.

Real Example: How This Played Out

Look at recent positioning in June:

• You had clear signs of heavy customer long puts well below spot — hedges against a correction that didn’t come.
  
• As the index broke higher, those puts decayed rapidly. At the same time, customers were long calls at higher strikes — the market moved toward these strikes, pulling dealers into forced buying.
  
• This created an imbalance: more upside chasing, less downside demand — exactly the conditions that crush skew.
  

If you’d tracked this flow, you wouldn’t be surprised that 1M skew traded down into the bottom third of its historical range while longer-term skew stayed firm.

How To Use This In Your Own Trading

The takeaway is not just that skew fell — it’s why it fell. Once you understand how dealer positioning drives these moves, you can use it to your advantage:

1. Track Flows and Positions

• Don’t just look at spot prices or volatility. Watch open interest shifts, dealer gamma positioning, and big flows in risk reversals.
  
• Tools like options flow trackers, gamma exposure maps, and skew percentiles help you see where the pressure points are.
  

2. Understand the Term Structure

• Near-term skew can behave very differently from longer-dated skew. When front-end positions are heavy in puts or calls, the impact on dealer hedging is much greater — this is where mechanical flows play out.
  
• For longer-term trades, remember that term structure (the shape of the volatility curve) matters for whether you should be long or short premium.
  

3. Align Your Strategy

• If you see a scenario where calls are crowded and the market is moving toward them, you know there could be forced dealer buying — which supports the spot rally.
  
• But if skew is collapsing, recognize that the reward for downside hedges is shrinking — so paying up for puts may not be worth it.
  
• You might instead play for mean reversion if the skew is at an extreme, or look at spreads that benefit from the relative movement between strikes.
  

Bottom Line: Positions Drive Paths

In the end, the market isn’t just about news or sentiment. It’s about flows — and those flows are driven by the inventory dealers and market makers have to manage. The recent FOMO-driven rally and the collapse in 1M skew show how positioning sets the stage long before the headlines catch up.

Smart traders don’t just react. They watch positions, understand dealer behavior, and use these insights to stay ahead of moves like this one.

When you do that, you’ll stop seeing a skew drop as a puzzle — and start seeing it as a signpost for what’s next.