Volatility skew is the pattern of implied volatility (IV) across strikes for the same expiration.
In equity index options (like SPX), out-of-the-money (OTM) puts typically carry higher IV than OTM calls. This “put skew” reflects demand for downside protection and the market’s left-tail risk.
Understanding skew helps with strike selection, wing sizing, pricing spreads, and avoiding systematically underpricing downside risk. In 0DTE strategies, intraday changes in skew can materially affect credits, hedge costs, and P&L.
1) The Basics: Smile, Smirk, and Skew
- Implied Volatility Surface: IV varies by strike (moneyness) and expiration (term).
- Volatility Smile: U-shape; both deep OTM puts and calls have higher IV (common in FX/commodities).
- Volatility Smirk / Put Skew (equities): IV generally higher for OTM puts than OTM calls at the same maturity.
- Vertical (Strike) Skew: IV vs. moneyness within one expiration (the key lens for 0DTE).
- Term Structure: IV vs. time to expiration.
2) Why Skew Exists (Equities/Indices)
- Crash protection demand: Institutions buy downside hedges → OTM put IV rises.
- Leverage effect: Spot down moves are associated with volatility up (negative spot/vol correlation).
- Dealer hedging pressure: Flow dynamics can keep put IV elevated when dealers are short puts.
- Asymmetric payoff preferences: Investors often accept paying more IV for convex downside protection.
3) How to Measure Skew (Practical Metrics)
Conventions differ, so define them explicitly. These are widely used and interpretable:
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25-Delta Risk Reversal (RR25)
We use: RR25 = IV_25Δ_call − IV_25Δ_put
In equities, RR25 is usually negative (puts trade at higher IV). If your convention uses put − call, the sign flips—be consistent.
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25-Delta Butterfly (BF25)
A curvature proxy:
BF25 ≈ 0.5 × (IV_25Δ_call + IV_25Δ_put) − IV_ATM
Higher BF indicates more “smile” curvature relative to ATM.
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Slope / Skew per Delta
Simple difference, e.g., IV_10Δ_put − IV_ATM, to gauge how quickly IV increases toward the downside tail.
0DTE tip: Measure skew on the same expiration around your actual entry time. Skew can change meaningfully after the open, around data releases, and into the close.
4) Reading Skew on a Chain (Fast Checklist)
- Prefer IV comparisons at matched deltas (e.g., 16Δ put vs. 16Δ call) within the same expiry.
(Mid-price credits are useful for trading decisions but mix IV with intrinsic/carry; use IV for measuring skew.)
- For spread construction, compare wing costs (e.g., long OTM put hedge cost vs. call hedge cost).
- Track ATM IV vs. OTM put IV; a widening OTM-minus-ATM gap usually indicates steeper downside skew.
5) Implications for Common 0DTE Strategies
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Short Strangle (delta-based)
- Steep put skew ⇒ the put side usually pays more for the same delta, reflecting higher downside risk.
- Practical response: consider wider put wing, smaller size, or stricter stops on the put side.
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Iron Condor
- Put spread often has more tail risk; the long put hedge can be relatively more expensive on steep skew days.
- Practical response: use asymmetric wings (wider put spread) or target credit per unit tail risk rather than forcing symmetry.
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Directional Vertical Spreads
- Bull put spreads benefit from richer put premiums but face higher gap risk; ensure credit compensates.
- Bear call spreads may look cheaper when put skew is steep; validate the reward vs. gamma/theta profile.
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Risk Reversal (sell put / buy call)
- In indices, this structure is typically short the expensive leg (put IV) and long the cheaper leg (call IV). Understand that you’re taking downside risk while leaning into prevalent skew pricing.
6) Skew Dynamics Specific to 0DTE
- Open (first 15–30 min): Spreads and IVs can be noisy; skew often re-anchors after the initial move.
- Event days (CPI, FOMC, NFP): Skew can reshape intraday; tails can richen or cheapen quickly post-release.
- Late day (time decay + gamma): As time collapses, far OTM wings can decay to near-zero or hold value if the tape trends; skew may flatten or steepen into the close depending on flows.
7) Practical Rules of Thumb
- Don’t assume symmetric risk: in indices, the put side usually has fatter tails.
- Don’t chase the highest credit blindly; evaluate credit vs. tail risk under current skew.
- Use asymmetric wings and position sizing to reflect skew conditions.
- Re-evaluate after large moves; skew can reprice and change roll/exit economics.
- Model execution (limit fills, timeouts); skewy markets often have wider spreads when you need to adjust.
8) FAQs
Does steep skew predict direction?
Not reliably by itself. It mainly reflects risk pricing and demand for protection.
Why is skew often steeper on down days?
Because spot ↓ ↔ vol ↑ (leverage effect) and put demand rises; quotes adjust accordingly.
Is skew relevant for same-day options?
Yes. Even in 0DTE, IV differences across strikes affect credits, hedge costs, and tail risk. Intraday skew changes can move P&L.
Key Takeaways
- Volatility skew describes how IV changes across strikes in the same expiry; equity indices usually show put-heavy skew.
- In 0DTE SPX trading, skew impacts credits, hedge costs, and downside tail risk.
- Backtest skew-aware rules (asymmetric wings, skew-regime filters, adaptive stops) using minute-level data and realistic execution modeling to see if they improve outcomes.
