in the strike price is higher for the downside options than it is for the upside
ones. The difference between the IV of the 31 strike is 2 full points higher
than the 32 strike, which is 1.8 points higher than the 33 strike. But the 36
strike’s IV is only 1.1 points higher than the 37 strike, which is also just 1.1
points higher than the 38 strike.
This incremental difference in the IV per strike is often referred to as the
slope. The puts of most underlyings tend to have a greater slope to their
skew than the calls. Many models allow values to be entered for the upside
slope and the downside slope that mathematically increase or decrease IVs
of each strike incrementally. Some traders believe the slope should be a
straight line, while others believe it should be an exponentially sloped line.
If the IVs were graphed, the shape of the skew would vary among asset
classes. This is sometimes referred to as the volatility smile or sneer,
depending on the shape of the IV skew. Although Exhibit 3.5 is a typical
paradigm for the slope for stock options, bond options and other commodity
options would have differently shaped skews. For example, grain options
commonly have calls with higher IVs than the put IVs.
Volatility skew is dependent on supply and demand. Greater demand for
downside protection may cause the overall IV to rise, but it can cause the
IV of puts to rise more relative to the calls or vice versa. There are many
traders who make their living trading volatility skew.