Key points
- Reflects fat tails: markets price in larger crashes than normal distribution.
- Skew = asymmetry: put volatility > call volatility after crashes (downside hedging demand).
- Smile collapses during calm periods, widens during stress.
Example
If at-the-money S&P 500 options imply volatility of 18%, puts 10% below the current level might imply 25%. That 7-point gap is the skew, reflecting demand for crash protection.
In history
Before the 1987 crash, implied volatility was roughly the same across strike prices. Since then, out-of-the-money puts have consistently been priced higher, a lasting premium for crash insurance.
Related terms