Volatility skew measures the gap in implied volatility between out-of-the-money put options and out-of-the-money call options on the same asset, revealing which direction the options market is paying a premium to hedge or speculate against.
What volatility skew tells you about sentiment
In traditional equity markets, put options almost always trade at a volatility premium over calls because investors are structurally afraid of sharp downside moves. Crypto markets behave differently: skew is far more dynamic, and during strong bull markets, call options frequently trade at a much richer volatility premium than puts because demand for upside leverage overwhelms demand for downside protection.
A deeply negative skew value indicates the market is pricing in a relatively high probability of an explosive upward move.
Trading the volatility smile and skew
When the 25-delta skew reaches a statistical extreme, for instance two standard deviations above its 90-day moving average, it often signals that institutional panic has temporarily inflated put prices well beyond what the underlying risk justifies. Contrarian quantitative traders can respond by selling the overpriced out-of-the-money puts and using part of that premium to purchase cheaper upside calls, a structure known as a risk reversal, entering a bullish position with a more favorable risk-to-reward profile than buying calls outright.
Practical execution guidelines
- Monitor Deribit and Amberdata's 7-day, 30-day, and 90-day skew charts in the days leading up to major macroeconomic catalysts, since skew tends to move sharply ahead of known event risk.
- Use skew normalization strategies to profit as extreme readings mean-revert back toward their historical average once the surrounding uncertainty resolves.
Skew is ultimately a sentiment gauge as much as a pricing tool. Reading it alongside spot price action often reveals when the crowd's fear or greed has become detached from what the underlying market is actually doing.