Put-Call Skew refers to volatility skew across put and call options of the same underlying asset and with the same expiration date.
Put-Call skew is typically most pronounced for out-of-the-money (OTM) options.
What is Downside Volatility Skew?
Usually Puts will have a higher implied volatility than Calls at similar distances from the current price of the underlying asset, i.e. the options are skewed to the downside.
What causes Downside Skew?
Most equities have downside skew because most investors are long stocks and the two common ways to use options in a long stock portfolio are:
- Buying out-of-the-money puts to hedge the downside risk of the stocks, i.e. buying a protective put. This demand for puts results in more expensive puts and thus higher implied volatility.
- Selling out-of-the-money calls to generate income, i.e. selling a covered call. This supply in calls results in cheaper calls and thus lower implied volatility.
What is Upside Volatility Skew?
In this case, Calls have a higher implied volatility than Puts at similar distances from the current price of the underlying asset, i.e. the options are skewed to the upside.
What causes Upside Skew?
Upside skew tends to occur in underlying assets in which the risk is to the upside, e.g. Inverse ETFs and volatility related products as the VIX Index, VXX and UVXY. Buying calls in these products has a similar hedge function as buying puts in equities.