Professional options desks view volatility skew not just as a feature of pricing, but as a tradable dimension of risk. Skew reflects relative demand for protection at different strikes, and when those relative prices appear misaligned, it creates opportunities for arbitrage, hedging efficiency, and relative-value trading.

Trading Skew Changes

Suppose the market shows an investment skew, where lower-strike puts carry higher implied volatility than higher-strike calls. If you expect the skew to flatten, one approach is to:

  • Sell lower-strike puts, which would fall in value as skew flattens
  • Buy higher-strike calls, which would rise in value as skew flattens

Example

Selling twenty 195 puts and buying twenty 220 calls creates exposure to skew normalization. To manage directional bias, you could hedge with the underlying to maintain a Delta-neutral position. On institutional desks, skew trades are often paired with overlays to control residual risks, such as variance swaps, dispersion trades, or dynamic Delta hedging protocols. Rival Risk models these exposures in real time, allowing traders to separate the skew, volatility, and directional components of the trade.
If instead you expect the skew to steepen, the reverse applies: buy lower-strike options and sell higher-strike ones.

Combining Skew and Volatility Views

Many skew expressions resemble simple vertical spreads, but institutional desks gain an edge by layering a volatility view on top of a skew view. This is where plain-vanilla structures evolve into targeted relative-value trades.

  • If volatility feels too low, buy at-the-money options as part of the skew spread
  • If volatility feels too high, sell at-the-money options within the skew trade

Examples

  • With the underlying at 207, if you expect skew to flatten and volatility to rise, you might buy 205 calls and sell 195 calls.
  • If you expect skew to flatten but volatility to fall, you might sell 210 calls and buy 220 calls.

These combinations allow traders to express two views simultaneously: the shape of skew and the level of volatility. When executed with discipline, the overlap between skew and volatility trading can provide a powerful source of relative value.

Practical Desk Applications

Professional desks rarely trade skew in isolation. Instead, skew views are often embedded in broader strategies, including:

  • Hedging Portfolios: Adjusting skew exposures in index options to manage downside protection costs without overpaying for volatility
  • Dispersion Trades: Exploiting differences between index skew and single-stock skew by buying or selling baskets of options against index options
  • Client Flow Management: Dealers often inherit skew exposures from client hedging demand. Actively trading the skew helps manage inventory and recycle risk more efficiently
  • Variance Swaps and Volatility Products: Using listed skew trades to hedge or enhance positions in over-the-counter volatility instruments

These applications highlight why skew is treated as its own asset within the volatility complex. It is not only a byproduct of demand, but also a lever desks actively trade to fine-tune risk and extract relative value.

Key Takeaways

  • Too Steep
    Buy low strikes, sell high strikes
  • Too Flat
    Sell low strikes, buy high strikes
  • Layer Volatility Views
    Incorporate at-the-money options to express both skew and volatility opinions
  • Desk Integration
    Skew trades often interact with broader positions, from client flows to dispersion strategies
  • Risk Factors
    Skew trades embed directional, Gamma, and Vega risks, which must be managed carefully

See Skew the Way Professional Desks Do

A trader with a clear view on volatility skew can generate returns when relative prices normalize or dislocate—just as with volatility or direction. But skew trades embed layered risks, including Delta, Gamma, and Vega, that evolve continuously as markets move. Without precise, real-time visibility, those risks can quickly overwhelm the intended relative-value thesis.

Rival Risk

Rival Risk gives institutional options desks real-time analytics on skew, volatility, and directional exposures across trades and portfolios. By isolating the drivers of P&L, firms can monitor skew normalization or steepening as it unfolds, stress-test positions against volatility shifts, and manage embedded risks with discipline.

For professional desks trading complex relative-value and volatility strategies, Rival Risk turns skew from an opaque byproduct of pricing into a measurable, controllable risk.

See how Rival Risk supports institutional options and volatility risk management by requesting a demo. 

 

This material is meant for educational purposes only. The information, strategies, and examples presented are not to be construed as trading or investment advice. Rival Systems does not endorse or recommend specific trading or investment decisions and users are encouraged to exercise their own judgement and seek professional advice before making any financial decisions.

Users are urged to carefully consider their financial objective, risk tolerance, and level of experience before engaging in trading or investment activities. Rival Systems is not responsible for any inaccuracies, errors, or omissions in the educational content or for any actions taken in reliance on such content.