Volatility skew
Quantitative Finance glossary · Derivatives Pricing & Volatility Surfaces
Definition
Monotonic strike dependence of implied volatility — in equity indices, σ_imp(K, T) slopes downward (OTM puts richer than OTM calls), a permanent regime since the 1987 crash. Economically: crash-fear / leverage effect, with empirical SPX skew steeper at short tenors. Captured naturally by stochastic-vol with negative spot-vol correlation, by jump-diffusion (downward jumps), or by Dupire local vol calibrated directly to the surface. Skew steepness is itself traded via risk-reversal σ_25Δ p - σ_25Δ c.
Volatility skew in plain English
Volatility skew is the market's built-in fear of crashes, made visible. If you look at stock-index options, the ones that pay off when the market falls (downside protection) are consistently priced with higher implied volatility than the upside ones — meaning people pay extra to insure against a plunge. That's because since the 1987 crash, everyone knows markets fall faster and harder than they rise, so downside insurance is permanently richer. Think of it like flood insurance being pricier for houses at the bottom of a hill: the lopsided pricing reflects a real lopsided danger, and traders can even bet on how steep that lopsidedness is.
Learn these first
Practice Volatility skew
Related Quantitative Finance terms
Quantitative Finance practice questions · Quantitative Finance flashcards · Quantitative Finance study guide