Understanding Volatility Skew: A Trader's Guide to Option Pricing Patterns

When you’re analyzing options markets, you’ll quickly notice that implied volatility (IV) isn’t uniform across different strike prices. This variation forms the foundation of what professionals call volatility skew—a critical concept for anyone serious about options trading. Instead of forming a straight line, the IV values across different strikes create distinctive curves that reveal crucial information about market sentiment and risk perception.

What Creates Volatility Skew in Options Markets

At its core, volatility skew emerges from the relationship between implied volatility and different strike prices for the same underlying asset and expiration date. When you map out these IV values—whether for at-the-money (ATM), in-the-money (ITM), or out-of-the-money (OTM) options—they rarely form a perfectly symmetrical pattern.

If the curve is balanced on both sides, it’s called a volatility smile. When it tilts to one side, creating an asymmetrical pattern, traders refer to this as a volatility smirk. The steepness of this tilt—what we call skewness—tells you how pronounced the market’s directional bias is at that moment. This simple visual pattern becomes remarkably powerful once you understand what’s driving it.

Two Dimensions of Volatility Skew: Horizontal vs. Vertical & Forward vs. Reverse

Volatility skew can be analyzed from two different perspectives, and experienced traders consider both when making decisions.

Horizontal vs. Vertical Skew examines where the variation occurs. Horizontal skew compares the same strike price across different expiration dates—how does the IV of a 100-strike call differ between a 30-day and 60-day contract? Vertical skew, by contrast, looks at how IV changes across different strikes on the same expiration date. Most traders focus their attention on vertical skew because it directly impacts the trades they’re considering for immediate implementation.

Forward and Reverse Skew describes the actual direction of the tilt. In a forward skew, higher strike options command higher implied volatilities than lower strikes—the market is pricing in greater uncertainty about upside moves. Conversely, reverse skew means lower strikes have higher IV, suggesting the market fears downside risk more severely.

Reading Market Psychology Through Volatility Skew Patterns

The shape of volatility skew is essentially the market’s probability forecast made visible. A steep forward skew signals bullish sentiment—traders are willing to pay a premium for the possibility of significant upward movement, which increases the value of call options. The opposite is true for reverse skew: a pronounced downward tilt indicates the market anticipates falling prices, and put options become more valuable.

You’ll notice reverse skew is especially common in markets where short-selling is either prohibited or prohibitively expensive. Here’s why: when investors can’t easily short to hedge downside risk, they rely heavily on put options for protection. This concentrated demand drives up IV on lower strikes, creating that characteristic downward skew regardless of other market conditions.

Applying Volatility Skew to Your Options Trading Strategy

Understanding volatility skew transforms from abstract theory into practical advantage when you’re building trades. The IV curve tells you which options the market fears are underpriced relative to others—and that’s exactly where opportunity lies.

In bullish markets, traders traditionally favor bull call spreads: buying at-the-money or slightly in-the-money calls while selling higher-strike calls. However, if the forward skew is shallow—meaning the market isn’t particularly excited about upside—you might find bull put spreads more attractive. These involve selling out-of-the-money puts while buying lower strikes, potentially requiring less capital while capturing similar directional exposure.

The key is matching your strategy to what the volatility skew pattern reveals about market pricing. When the curve is steep in one direction, it signals strong market conviction. When it’s flat, it suggests uncertainty. By reading these patterns, you’re essentially gaining insight into what sophisticated market participants already believe will happen—and positioning your trades accordingly becomes far more informed.