6. Volatility Skews

Describes that option contracts for the same underlying asset—with different strike prices, but which have the same expiration—will have different implied volatility (IV)
Can be seen as a predictor of where IV will be when stock price reaches certain strike price
Because of this, most options are initiated by using delta as a criteria for stricke selection, since delta takes into account IV skew information

Volatility smiles tell us that demand is greater for options that are in-the-money or out-of-the-money
The volatility smile skew pattern is commonly seen in near-term equity options and options in the forex market

The reverse skew pattern typically appears for longer term equity options and index options
In the reverse skew pattern, the IV for options at the lower strikes are higher than the IV at higher strikes
Suggests that in-the-money calls and out-of-the-money puts are more expensive compared to out-of-the-money calls and in-the-money puts
The popular explanation for the manifestation of the reverse volatility skew is that investors are generally worried about market crashes and buy puts for protection
Another possible explanation is that in-the-money calls have become popular alternatives to outright stock purchases as they offer leverage and hence increased ROI. This leads to greater demands for in-the-money calls and therefore increased IV at the lower strikes

The IV for options at the lower strikes are lower than the IV at higher strikes.
This suggests that out-of-the-money calls and in-the-money puts are in greater demand compared to in-the-money calls and out-of-the-money puts
The forward skew pattern is common for options in the commodities market. When supply is tight, businesses would rather pay more to secure supply than to risk supply disruption