Theoretically, all options for a specific underlying asset (e.g. a stock, an index or ETF) should trade with the same implied volatility.

In practice, the supply and demand for particular option contracts can skew the option prices and consequently also the implied volatilities.

**Volatility Skew**, also known as **Option Skew**, refers to this **difference in implied volatility (IV)** between option contracts with the same underlying asset. It is the variance of the theoretical implied volatility.

Option skew is typically most pronounced for out-of-the-money (OTM) options.

## What are the 3 Types of Volatility Skew?

Option contracts with the same underlying asset can have **three types **of volatility skew:

**Put-Call Skew**

Refers to**volatility skew across put and call options**with the same expiration date. Usually puts will have a higher implied volatility than calls, i.e. the options are skewed to the downside.

Learn more about Put-Call Volatility Skew**Horizontal Skew**or**Time Skew**(Term Structure)

Refers to**volatility skew across options with different expiration dates**(maturities) at the same strike price. Usually longer-term options trade with lower implied volatilities than do short-term options.

Learn more about Horizontal Volatility Skew**Vertical Skew**or**Strike Skew**

This is the**most common type**of Volatility Skew, it refers to**volatility skew across options with different strike prices**at the same expiration dates. Usually out-of-the-money and in-the-money options have a higher implied volatility than at-the-money options.

Learn more about Vertical Volatility Skew

Volatility skew changes over time as market sentiment changes and will always **disappears at expiration**.

*Notice that the implied volatility of the at-the-money (ATM) options is the recognized “reference volatility”.*

## How can traders take advantage of Volatility Skew?

The options volatility skew, which is affected by sentiment and the supply and demand relationship of particular options in the market, **provides information on the expectations** of market participants.

When a particular option contract is bought a lot then its price will increase and consequently indicate higher implied volatility. Conversely, an option contract that is sold a lot will fall in price and consequently indicate lower implied volatility.

Put-Call volatility skew, for example, can give three useful pieces of trading insight:

- What is the perceived
**direction risk in the underlying asset**?

Downside Skew indicates that the market is pricing in more downside risk for the underlying asset. Upside Skew indicates the opposite. **How implied volatility will change**relative to movements of the underlying asset?

The implied volatility of equities with downside skew tend to increase when the price of the underlying equity falls. E.g. the overall market S&P 500 Index (SPX) has typically downside volatility skew; when the SPX falls the VIX Index (volatility of SPX) will rise.**When to trade Call Spreads or Put Spreads?**

With downside volatility skew, OTM puts trade more expensive than OTM Calls. Consequently, put spreads trade cheaper than call spreads, which is beneficial for debit put spread buyers and credit call spread sellers.

With upside volatility skew, OTM calls trade more expensive than OTM puts. Consequently, call spreads trade cheap and put spreads trade expensive, which is beneficial for credit call spread buyers and debit put spread sellers.