Volatility Skew

If option prices perfectly matched the standard Black–Scholes model, all options on an asset with the same expiry would show the same implied volatility. In practice, they do not.

In equity markets, options with lower exercise prices, especially out-of-the-money puts, usually have higher implied volatility than options with higher exercise prices. This downward-sloping pattern reflects strong demand for protection against market falls, and the fact that large falls tend to happen more suddenly than large rises.

For example, on a stock index trading at 5,000, a put with an exercise price of 4,500 might have an implied volatility of 25%, while a call at 5,500 has an implied volatility of 15%.

The shape varies by market. Currency options often show a more symmetrical smile, with higher implied volatility for both low and high exercise prices. Some commodity options show higher volatility for high exercise prices, reflecting the risk of supply shocks. Traders monitor skew to judge market sentiment and price options more accurately.