To analyze skew in implied volatility (IV) for trading opportunities, start by observing the differences in IV across options with different strike prices but the same expiration date. A steep IV skew (where out-of-the-money options have higher implied volatility) might indicate high market uncertainty or expected volatility. Conversely, a flat or inverted skew can suggest low expected volatility. By analyzing these trends, you can spot potential price moves and mispriced options, giving you an edge in identifying trading opportunities.

What is Implied Volatility Skew?

Implied volatility skew refers to the difference in implied volatility across options with the same expiration date but different strike prices. Typically, out-of-the-money options (both calls and puts) have higher implied volatility than at-the-money options. This occurs because market participants anticipate higher movement in these options, either due to potential price breakouts or other factors.

Why Is Analyzing IV Skew Important for Trading?

By analyzing implied volatility skew, traders can identify market sentiment, forecast potential price movements, and spot overvalued or undervalued options. A sharp change in the IV skew, for example, may indicate a potential market breakout or significant price action. It can also help assess whether an option is overpriced or underpriced based on current market conditions, providing opportunities to execute more profitable trades.

What Does a Steep Implied Volatility Skew Indicate?

A steep implied volatility skew, where out-of-the-money options have significantly higher implied volatility, indicates that the market expects large price movements, often due to uncertainty or anticipated news. This skew suggests traders are willing to pay more for out-of-the-money options in anticipation of large market swings, either upward or downward. This can signal a potential trading opportunity if you can anticipate the direction of the move.

What Does a Flat or Inverted IV Skew Mean?

A flat or inverted IV skew suggests lower expected volatility in the market. When implied volatility is similar across strike prices, the market is likely calm and not expecting major price swings. An inverted IV skew, where puts have lower implied volatility than calls, can sometimes indicate a bullish sentiment, as traders are not expecting a significant downside risk. This can be a good time to enter trades that capitalize on market stability.

How to Identify Breakouts Using IV Skew?

Traders can use IV skew to spot potential breakouts in the market. When there is a sudden change in the IV skew, particularly when the skew steepens, it might indicate that traders expect a significant price move soon. Monitoring changes in the IV skew can help you anticipate price movements and trade options to take advantage of breakout opportunities.

Which Tools Are Best for Analyzing IV Skew in India?

In India, platforms like Sensibull, Opstra, Angel One Smart API, Fyers One, and TradingView offer excellent tools to visualize IV skew. These tools help traders track implied volatility trends, detect changes in skew, and make data-driven decisions when executing trades. You can also use NSE’s option chain for manual analysis of IV skew at different strike prices.