§ 01
| Surface Feature | What It Looks Like | What It Tells the Investor |
|---|---|---|
| Smile | Far-OTM strikes (both up and down) have higher IV than ATM strikes -- the curve smiles upward at both wings | Common in FX, commodities, and single-stock options. Reflects fat tails: the market thinks big moves in either direction are more likely than a normal distribution would suggest |
| Skew (Downside) | OTM puts price at much higher IV than OTM calls -- the curve slopes down from left to right | Persistent in equity indices since 1987. Reflects structural demand for crash protection from institutional hedgers. The asymmetry is the price of tail insurance |
| Term Structure (Contango) | Longer-dated options price at higher IV than near-dated -- the curve slopes upward across expirations | Common in calm markets. Tells you the market expects normal levels of future volatility but is uncertain about the long horizon |
| Term Structure (Backwardation) | Near-dated options price at higher IV than longer-dated -- the curve slopes downward across expirations | Common during crises. Tells you the market expects elevated short-term turbulence that will mean-revert. Hedging near-term events is more expensive than hedging longer-term |
§ 02
The volatility skew is not a temporary mispricing -- it is a structural feature of equity index markets. Anyone telling you 'puts are too expensive, sell them' has not absorbed why they are expensive. The skew compensates put-sellers for the fact that crashes happen suddenly and most short-put positions blow up at the worst possible moment.
§ 03
Pull an option chain on the S&P 500 ETF (SPY) for the same expiration. Compare the implied volatility of a put about 10 percent below spot with a call about 10 percent above spot. The gap you see is the skew. Now pull a single-stock chain, ideally a high-beta name. Compare the same strikes. Notice that single-stock skew is usually wider than index skew -- single-name crashes (earnings misses, fraud, takeover blowups) are even harder to hedge than index drawdowns.
§ 04
You are looking at the SPY option chain on a calm day. The VIX is at 13. The downside skew is unusually narrow -- the 10-percent OTM put trades at only 16 percent IV versus 14 percent on the ATM strike. A friend says, 'this is the perfect time to sell puts because the skew has compressed and they are cheap relative to history.' What is the most disciplined reading?
§ 05
§ 06
You compare the option chains on the S&P 500 ETF and on a single-stock high-beta biotech name. The S&P 500's 10-percent OTM put trades at 25 percent IV vs. 18 percent ATM (a 7-point downside skew). The biotech's 10-percent OTM put trades at 65 percent IV vs. 45 percent ATM (a 20-point downside skew). What does the much steeper single-stock skew tell a lifelong investor?
Five questions · AI feedback
Sit with the ideas.
You pull the S&P 500 option chain. At a single expiration, the 10-percent out-of-the-money put trades at 28 percent implied volatility while the 10-percent out-of-the-money call trades at 17 percent implied volatility. The at-the-money straddle trades at 19 percent. Which statement best explains this pattern to a lifelong investor?
Why: