Skew, in the context of crypto options trading, refers to the phenomenon where implied volatilities for options contracts with the same underlying asset and expiration date vary across different strike prices. Specifically, it describes the asymmetric distribution of implied volatility, often showing higher implied volatility for out-of-the-money (OTM) calls or puts relative to at-the-money (ATM) options. Its purpose is to quantify the market’s perception of future price movements, reflecting supply-demand dynamics and perceived tail risks.
Mechanism
The mechanism of skew arises from market participants’ demand for hedging against specific price scenarios or speculating on extreme movements. For example, a “crash skew” indicates higher demand for OTM puts, driving their implied volatility up, as traders seek protection against significant downside. Conversely, “upside skew” may suggest demand for OTM calls. This imbalance is reflected in the option prices and, consequently, their implied volatilities, deviating from a theoretical flat volatility surface.
Methodology
Analyzing skew involves constructing a volatility surface from observed options prices and plotting implied volatilities against strike prices for various maturities. Traders use this data to identify mispricings, gauge market sentiment, and calibrate risk models for options portfolios. Strategies such as trading volatility spreads or utilizing complex options structures are employed to capitalize on or hedge against specific skew characteristics, particularly in institutional options trading within crypto.
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