Volatility Skew and Smile: Why Put Options Are More Expensive Than Calls
Summary
Volatility skew refers to the phenomenon where out-of-the-money put options have higher implied volatility (and are therefore more expensive) than equidistant out-of-the-money call options. This occurs because institutional investors consistently buy puts for portfolio protection, creating demand that inflates their prices. The skew reveals the market's fear premium and creates opportunities for traders who understand when skew is unusually steep or flat.
Key Takeaways
Volatility skew exists because demand for downside protection (puts) exceeds demand for upside speculation (calls). The skew is measured by comparing IV at different strikes. Normal skew for equities is 5-15% higher IV for 25-delta puts compared to 25-delta calls. When skew is steeper than normal, put spreads are relatively expensive (opportunity for selling). When skew is flatter than normal, puts are cheap (opportunity for buying protection). Skew steepens during market stress and flattens during calm, complacent markets.
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Pull up any stock's options chain and compare a 25-delta put to a 25-delta call at the same expiration. The put will almost always have a higher implied volatility. On SPY, a typical difference is 3-8 IV points. On individual stocks, it can be 10-20 points.
This isn't random. It's the single most persistent pattern in options pricing, and understanding it is worth real money.
What Creates the Skew
Institutional Put Buying
Pension funds, mutual funds, and endowments collectively hold trillions in stock portfolios. They routinely buy put options as insurance against market declines. This constant, size-independent demand pushes put prices (and therefore their implied volatility) higher than equivalent calls.
The demand is structural, not speculative. It doesn't disappear during bull markets because insurance is always being purchased. It intensifies during bear markets because fear drives additional buying.
The 1987 Crash Legacy
Before the 1987 crash (Black Monday, when the Dow dropped 22% in one day), options pricing assumed symmetric return distributions. After the crash proved that markets can fall much faster than they rise, options traders permanently repriced puts to reflect this tail risk. The skew has existed in every major equity market since.
Real-World Return Distributions
Stock returns are not normally distributed. They have "fat tails," meaning extreme moves (particularly to the downside) happen more often than a bell curve would predict. The skew incorporates this reality: the probability of a 10% down move is higher than a 10% up move, so the options that protect against that move should cost more.
How to Measure Skew
The 25-Delta Skew
The standard measurement compares the IV of the 25-delta put to the 25-delta call:
Skew = IV of 25-delta put - IV of 25-delta call
Example on SPY:
The Skew Percentile
Just as IV percentile tells you whether IV is high or low relative to history, skew percentile tells you whether the current skew is steep or flat compared to its historical range.
High skew percentile (above 70%): Puts are unusually expensive relative to calls. The market is pricing in more fear than usual.
Low skew percentile (below 30%): Puts are relatively cheap. The market is complacent about downside risk.
What Skew Tells You About Market Sentiment
Steep Skew = Fear
When institutional investors are worried about a market decline, they buy more puts, steepening the skew. Steep skew during a calm market can be a warning sign: the people who manage billions are hedging aggressively despite the lack of obvious catalysts.
Flat Skew = Complacency
When the skew flattens (puts become relatively cheaper), it often signals complacency. The institutions are less interested in hedging, which historically has preceded some of the sharpest market declines.
This creates a counter-intuitive signal: the time to buy protection (puts) is when skew is flat (complacency), not when it's steep (fear). Buying puts during fear means overpaying for insurance. Buying during complacency means getting cheap insurance before a potential selloff.
Trading Opportunities from Skew
When Skew Is Steep (Sell Puts, Buy Calls)
Steep skew means puts are expensive. Selling put spreads (bull put spreads) in this environment gives you above-average premium because the short put's elevated IV generates richer credits.
Conversely, calls are relatively cheap. Buying call spreads (bull call spreads) costs less than average because the long call's lower IV makes it affordable.
When Skew Is Flat (Buy Puts, Sell Calls)
Flat skew means puts are cheap. Buying protective puts costs less than usual, making portfolio hedging more cost-effective. This is the time to add insurance.
Selling call spreads or covered calls in a flat-skew environment is less attractive because calls aren't as overpriced as usual.
Skew-Based Vertical Spread Selection
When choosing between a bull put spread (credit) and a bull call spread (debit) for a bullish thesis:
Steep skew: Bull put spread is better (puts are overpriced, sell them) Flat skew: Bull call spread is better (calls are cheap, buy them)
This subtle adjustment aligns your strategy with the volatility environment and captures the skew premium.
Skew Across Different Assets
Equity indexes (SPY, QQQ): Always display negative skew (puts more expensive). The skew is 3-8 IV points in calm markets and 10-20+ points during stress.
Individual stocks: Typically display negative skew, but the magnitude varies. High-beta tech stocks have steeper skew than low-beta utilities.
Commodities and currencies: May display different skew patterns depending on supply/demand dynamics. Oil options, for example, can have call skew (calls more expensive) during supply disruption fears.
Practical Takeaway
Check the skew before selecting your strategy. If you're selling premium, lean into the side of the chain where IV is highest (usually puts during normal skew). If you're buying, lean into the side where IV is lowest (usually calls). This subtle adjustment compounds into meaningful edge over hundreds of trades.
OptionsPilot's strike finder displays IV at each strike, making it straightforward to visualize the skew and identify whether puts or calls are offering better value for your intended strategy.