Options skew refers to the pattern of implied volatility across different strike prices and expiration dates. It describes how the implied volatility of options varies depending on whether they are in-the-money, at-the-money, or out-of-the-money.

The skew can provide insights into market sentiment and expectations. A steep skew might indicate increased concern about potential downside risk, while a flatter skew could suggest a more neutral sentiment.

Tutorial on how to Read the SKEW

Introducing you to the Menthor Q SKEW

The skew represents the implied volatility differences between out-of-the-money (OTM) call and put options. Typically, OTM puts have higher implied volatility than OTM calls, reflecting market participants’ fear of downward moves.

We take the 25 Delta Skew also known as Risk Reversal for the next expiration or 0DTE, 1 Month and 3 Months.

The 25-delta skew is a valuable indicator that provides insights into market sentiment and traders’ expectations about future price movements. Here’s what the 25-delta skew can reveal:

Bullish Sentiment

  • Lower Implied Volatility for Calls: If the implied volatility of 25-delta call options is lower than that of 25-delta put options, it suggests that the market is less concerned about significant upward moves. This indicates a more stable or moderately bullish outlook.
  • Steeper Call Skew: When the skew is steeper for calls, it may indicate strong bullish sentiment. Investors are willing to pay a premium for calls because they anticipate significant upward price movements.

Bearish Sentiment

  • Higher Implied Volatility for Puts: If the implied volatility of 25-delta put options is higher than that of 25-delta call options, it reflects greater market concern about potential downward moves. This indicates a bearish outlook, as traders are seeking protection against declines.
  • Steeper Put Skew: A steeper skew for puts suggests that investors are more worried about downside risk and are willing to pay a higher premium for put options to hedge against potential losses.

Neutral Sentiment

  • Balanced Volatility: When the implied volatility for 25-delta calls and puts is relatively balanced, it indicates that the market does not have a strong directional bias. Traders expect the underlying asset to remain within a certain range.
  • Flat Skew: A flat skew suggests that there is no significant concern about large price swings in either direction, reflecting a neutral sentiment.

Practical Examples

Risk Management

  • Hedging: Higher implied volatility for puts can indicate a good opportunity for hedging against downside risk. Conversely, lower volatility for calls might suggest that calls are cheaper, offering a cost-effective way to gain upside exposure.
  • Premium Collection: Traders can take advantage of higher premiums on puts in a bearish market by selling puts to collect higher premiums, assuming they are comfortable with the risk of being assigned the underlying asset.

Trade Timing and Strategy

  • Entry and Exit Points: Understanding the skew can help identify optimal entry and exit points. For example, in a bullish market with a steep call skew, buying calls or selling puts might be more favorable.
  • Strategic Adjustments: Traders can adjust their strategies based on changes in the skew. A shift from a steep put skew to a flatter skew could signal a transition from bearish to neutral or bullish sentiment.

Market Predictions

  • Anticipating Movements: Significant changes in the skew can precede major market movements. A sudden increase in put volatility could indicate rising fear and potential for a market downturn, while a spike in call volatility might signal upcoming bullish activity.
  • Volatility Expectations: The skew helps in understanding how the market perceives future volatility. A steep skew suggests high expected volatility, while a flatter skew indicates lower expected volatility.

Here is a sneak peak of the Menthor Q SKEW Chart!

We provide 3 SKEW Charts:

  • 0DTE or Next Expiration Skew
  • 1 Month Skew
  • 3 Months Skew
Menthor Q Skew - SKEW TSLA
Menthor Q Skew 5

Within the SKEW Chart you also have access to relevant data points to help you understand historical changes:

  • Put and Call Bias. You can immediately see if we are in a Put or Call Bias environment.
  • 3 Month Percentile. Access the Percentile to understand how SKEW today compares to its history.
  • 30 Day Min, Max and Average. By quickly having access to these statistics you can compare current volatility regime with the past.