Vertical Skew
The second type of skew found in option IV is vertical skew, or strike skew.
Vertical skew is the disparity in IV among the strike prices within the same
month for an option class. The options on most stocks and indexes
experience vertical skew. As a general rule, the IV of downside options—
calls and puts with strike prices lower than the at-the-money (ATM) strike
—trade at higher IVs than the ATM IV. The IV of upside options—calls and
puts with strike prices higher than the ATM strike—typically trade at lower
IVs than the ATM IV.
The downside is often simply referred to as puts and the upside as calls.
The rationale for this lingo is that OTM options (puts on the downside and
calls on the upside) are usually more actively traded than the ITM options.
By put-call parity, a put can be synthetically created from a call, and a call
can be synthetically created from a put simply by adding the appropriate
long or short stock position.
Exhibit 3.5 shows the vertical skew for 86-day options on Citigroup Inc.
(C) on a typical day, with IVs rounded to the nearest tenth.
EXHIBIT 3.5 Citigroup vertical skew.
Notice the IV of the puts (downside options) is higher than that of the
calls (upside options), with the 31 strike’s volatility more than 10 points
higher than that of the 38 strike. Also, the difference in IV per unit change