Put skew is a term used in the options market to describe the difference in the price of put options with different strike prices. Typically, put options with lower strike prices tend to be more expensive than those with higher strike prices. This is because investors are often willing to pay more for protection against larger market downturns. Put skew can tell us a lot about market sentiment and the level of perceived risk in the market.

What is Put Skew in Options Markets?

Put skew refers to the difference in the prices of put options that have different strike prices. Usually, put options with lower strike prices are more expensive than those with higher strike prices. This happens because investors are willing to pay more for protection in case the market crashes or drops significantly. The pattern in these prices gives us insight into market expectations and risk perception.

Why is Put Skew Important?

Put skew helps traders understand market sentiment and expectations. When put skew is high, it indicates that investors are worried about a potential market downturn and are buying more puts for protection. Conversely, when the put skew is low, it suggests that investors are less concerned about a big drop in the market. Therefore, analyzing put skew gives insights into how risky investors perceive the market to be.

How to Analyze Put Skew?

To analyze put skew, you need to observe the difference in prices of puts with different strike prices. If put options with lower strikes are significantly more expensive than those with higher strikes, it signals that investors are worried about the downside. This often happens during times of uncertainty or market volatility. By tracking this pattern, you can get a better understanding of how investors are positioning themselves in the market.

What Does High Put Skew Indicate?

A high put skew means that put options with lower strike prices are much more expensive than those with higher strikes. This typically indicates that investors are worried about the market dropping sharply. When investors start to pay a premium for protection, it shows that they fear a potential downturn or crash in the market.

How Does Put Skew Affect Trading Decisions?

Put skew can influence trading decisions by showing you how investors are positioning themselves for potential risk. If put skew is high, you might consider reducing your exposure to risky assets, as it indicates that others are hedging against a market decline. On the other hand, a low put skew might suggest that you can take on more risk, as investors are less concerned about market drops.

Limitations of Using Put Skew

While put skew can be a helpful indicator, it isn’t foolproof. It doesn’t always predict market movement accurately. For example, during periods of low volatility, put skew might not provide much useful information. Also, high put skew doesn’t necessarily mean the market will crash, it just means that investors are more concerned about the downside risk. Therefore, it's best to use put skew along with other market indicators.