How Option Skew Reflects Demand for Downside Protection
Option skew tells you in price terms how much the market is willing to pay for downside protection. When put options are significantly more expensive than call options, the skew is steeper, signaling stronger demand for protection. When prices of puts and calls are close to each other, the market is not particularly worried about a sharp decline.
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Find the skew data – read the price difference on the options chain
What to do: On an options trading page, locate options with the same expiration but different strike prices. Observe the implied volatility (IV) difference between out-of-the-money puts and out-of-the-money calls.
How to do it:
On the options chains of Deribit, OKX, or Binance, filter for the same expiration (e.g., current week or month).
Compare the IV of out-of-the-money puts (strike below the current price) with that of out-of-the-money calls (strike above the current price).
If OTM puts show markedly higher IV than OTM calls, the skew is a "put skew," indicating strong demand for downside protection.
Some platforms (e.g., Glassnode) provide more comprehensive skew indices that aggregate IVs of all out-of-the-money options across the entire volatility surface, giving a more accurate reading than looking at just one or two strikes.
When it's complete: You can see the IV gap between puts and calls for the same expiration, and know which side is more expensive and by roughly how much.
Interpreting the direction of skew – positive or negative
What to do: Determine whether the current skew is predominantly put-driven or call-driven.
How to do it:
Negative skew (OTM put IV > OTM call IV): The market is buying downside protection. Put demand is robust, and traders are willing to pay a premium to hedge against a price decline.
Positive skew (call IV > put IV): The market is in a bullish mood. Call demand is rising, and traders are paying a premium for upside exposure.
Take the CME's interpretation of VIX-type metrics as an example: a skew ratio below 1.0 implies bearish or downside sentiment in the market; a ratio above 1.0 leans bullish.
When it's complete: You know whether the market is currently "fearing a drop" or "chasing a rally."
Key reminder: Skew reflects asymmetry, not direction. A negative skew means there is strong hedging demand against a large decline, but it does not mean prices are guaranteed to fall – the market is simply pricing in that possibility.
Look at the steepness of the skew – the steeper it is, the stronger the protection demand
What to do: Calculate the IV gap between OTM puts and at-the-money puts (or at-the-money calls) for the same expiration, to quantify how steep the skew is.
How to do it:
Compare: IV of 10% OTM puts vs. IV of ATM options.
In the U.S. equity market, NDX options have historically shown OTM call IV averaging only about 59% of OTM put IV; the gap can be even larger during extreme periods.
In the crypto market, Glassnode analysis shows that short-term skew has steepened overall, indicating that demand for downside protection remains strong.
A steepening skew means that the cost of downside protection is rising, typically corresponding to heightened fear or uncertainty.
When it's complete: You have a clear idea of whether the current skew is "mild," "steep," or "extreme," and can compare it to recent history.
Compare skew across different tenors – is the fear short-term or long-term?
What to do: Look at near-term (1 week to 1 month) and longer-term (3 months to 6 months) skew simultaneously to assess the persistence of fear.
How to do it:
Near-term skew is extremely negative while long-term skew is neutral or positive: This suggests short-term fear is event-driven, and the market is not pessimistic about the medium-to-long term. This is a classic "transient shock" signal.
Both near-term and long-term skew are extremely negative: The market is also pricing in medium-to-long-term downside risk, potentially reflecting systemic concerns.
According to Glassnode's analytical framework, such a tenor divergence occurred in June 2022 – the 1-week skew plunged while 3-month and 6-month skews were still rising, indicating that the fear was mostly short-term in nature.
When it's complete: You can describe whether the current market uncertainty is concentrated in the "near term" or the "long term."
Integrate the skew reading into your decision-making framework
What to do: Based on the skew reading, decide how to adjust your position risk management.
How to do it:
Scenario A – extremely negative skew (downside protection is very expensive): The market is pricing tail risk. If you hold a position, consider whether to add some protection even though it is already pricey. If you are sitting out, extremely negative skew often appears at panic peaks and can serve as a contrarian observation window.
Scenario B – extremely positive skew (calls are very expensive): The market may be gripped by FOMO, with upside expectations fully priced in. Academic research shows that when NDX call skew is extreme, near-term performance may be unstable, but stretching to 10–20 days, outcomes after extreme call skew can actually be better than average.
Scenario C – skew persistently low (downside protection is very cheap): The market is in a state of complacency. If a negative catalyst suddenly appears, positions lacking hedges will face larger downside shocks.
When it's complete: You have adjusted your position's risk management setup, or defined the conditions for making an adjustment, based on the skew reading.
Prerequisites
Before performing this type of analysis, make sure your trading platform offers options data capabilities, or that the market tools you use (such as Deribit, Glassnode, TradingView) can display IV curves for the same expiration date. If you do not have options trading access, skew analysis can only serve as a sentiment reference and cannot be acted on directly.
Common reasons for misreading skew
The most common misinterpretation: treating "negative skew" as a direct signal that "prices will fall." Skew tells you the market is buying downside protection, not that the market expects prices to drop. Another frequent issue: focusing on the skew from a single strike price while ignoring the structure of the entire volatility curve. Using a single data point can distort the picture – it is advisable to observe the curve's overall shape.
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Risk warning
Capital risk: When skew is at extreme levels, whether buying or selling either side of options, you may face high premium costs. Buying puts for protection when skew is extremely negative can already be very expensive.
Account risk: A sudden mean reversion in skew (a rapid decline in put IV) can mean that market sentiment shifts abruptly, and the value of previously purchased downside protection can shrink quickly.
Compliance risk: None.
Signs that you have completed the analysis correctly: You can answer four questions – What is the current IV gap between puts and calls? Where does this gap stand relative to recent history? Are near-term and long-term skews aligned? Based on this reading, what adjustments are you prepared to make to your positions? If you can answer all of these clearly, skew analysis has served its purpose. Next step: If you are holding spot or futures longs and short-term skew is extremely negative, consider using a small portion of capital to buy puts as tail-risk protection. If you are flat, extremely negative skew often represents a high-risk, high-reward observation window – do not rush in; wait for the skew to begin normalizing before reassessing direction.
