Skip to content
All library documents

Interpreting Equity Put Skew and Option Premiums

Article Quant Q&A · Author: TRex
Read the original

Summary

The document addresses a common confusion about equity put skew: a farther out-of-the-money put can have a higher implied volatility than a nearer out-of-the-money put, yet still cost less in premium. Implied volatility describes the volatility input that makes an option’s model price match its market price; it is not the option’s dollar price or a direct ranking of premiums across strikes.

The response clarifies that the nearer-strike put has a higher premium in the example, while the farther put is relatively more expensive when compared with a flat-volatility Black–Scholes benchmark. This distinction helps reconcile the apparent contradiction: strike, payoff probability, and volatility all affect price. The brief exchange offers no numerical premiums or broader treatment of skew construction, so it serves as a conceptual clarification rather than a method for valuing or selecting puts.

Key ideas

  • A higher implied volatility at one strike does not mean its option premium is higher than at another strike.
  • The nearer out-of-the-money put can have a larger premium than the farther put.
  • Skew describes implied volatility relative to strike, often compared with a flat-volatility benchmark.
  • Option premium depends on more than implied volatility alone.

Tags

OptionsVolatilityDerivatives pricing
Full text
# Confusion with the equity option skew


# Confusion with the equity option skew












In general out of the money (OTM) equity options have higher implied volatility (IV) than at the money (ATM) options. So assuming we have two put options (5% OTM and 10% OTM). Skew reveals that 10% OTM will have higher IV i.e. more expensive. If that be the case why would one not buy 5% OTM option instead for less + get higher protection?! am I missing something here?

## Answer by Bob Jansen (score 3)

https://quant.stackexchange.com/a/68919

It’s relatively more expensive compared to the BS price with flat volatility. The option premium of the 5% OTM put is higher than the 10% OTM put.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.