Introductory Context
"Implied volatility on the option chain varies by strike — typically lower at ATM and higher for OTM puts and calls. The pattern across strikes is the volatility smile or skew. In Indian index options, the skew is asymmetric — OTM puts have higher IV than OTM calls, reflecting institutional demand for downside protection. "
What Implied Volatility Means at Each Strike
Implied Volatility (IV) is the market's collective estimate of how much the underlying will move, implied backwards from the current option premium using an options pricing model. Each strike has its own IV because the market assigns different probabilities to different outcomes at different price levels.
On the NSE option chain, the IV column shows the IV for each call and put at each strike. Looking down the call IV column, you will notice that IV is not constant — it typically varies across strikes in a characteristic pattern. This variation is the volatility smile.
The Volatility Smile — Why OTM IV Is Higher
In a theoretically perfect world where log-normal price distributions hold (as assumed in Black-Scholes), IV would be constant across all strikes — a 'flat smile.' In practice, IV is not constant. In Indian index options, IV typically follows a skewed pattern:
• IV is significantly higher than ATM Deep OTM puts (far below current spot):
• IV is at its lowest level across the chain — the 'trough' of the smile ATM (current spot level):
• IV rises modestly above ATM Slightly OTM calls:
• IV is somewhat higher than ATM, but typically lower than deep OTM put IV Deep OTM calls:
This asymmetric pattern — where OTM put IV is higher than OTM call IV — is the volatility skew. It is sometimes called the 'smirk' (because the smile is asymmetric, leaning more to the left/put side).
Why OTM Puts Have Higher IV in India
The skew exists because of asymmetric demand for tail risk protection. Portfolio managers, FIIs, and large equity investors systematically buy OTM puts to protect their equity holdings from large market falls. This demand for downside protection pushes OTM put prices — and therefore OTM put IV — above what a symmetric distribution would imply. The skew reflects the market's genuine belief (supported by historical experience) that sharp downside moves are more probable than symmetry would suggest.
Reading the Skew as a Market Signal
A steep skew (OTM put IV much higher than OTM call IV) indicates high demand for downside protection — the market is pricing in significant downside risk. A flat or symmetric skew indicates the market sees roughly balanced upside and downside risks. During pre-Budget uncertainty, India VIX and the overall IV level rise, but the skew sometimes flattens as two-directional uncertainty (the Budget could be very good or very bad) increases demand for both OTM calls and puts proportionally.
Using IV Distribution in Trade Decisions
Identifying Relatively Cheap and Expensive Options
By comparing the IV at your intended strike to the ATM IV and to the typical IV at that strike over recent weeks, you can assess whether the option you want to buy is relatively cheap or expensive. If the 24,700 CE typically has IV of 14% and today shows IV of 20%, the option is expensive relative to its own history — you are paying more premium than usual for this strike's exposure.
Strike Selection Refinement
When two strikes have similar delta (similar probability of expiring ITM), the one with lower IV is generally the better buy — you are getting equivalent directional exposure for lower cost. This IV comparison across comparable strikes is a refinement of the delta-based strike selection covered in Module 3.
Identifying Event-Driven IV Spikes
Before major scheduled events (Budget, RBI, results), IV typically rises across all strikes. But it often rises unevenly — ATM and near-OTM options see the largest IV increases because these are the strikes most affected by uncertainty about the event's direction. Tracking how IV builds across the chain in the days before an event helps you decide the optimal entry timing.
The IV Percentile Check
Before buying any option, check whether the current IV at your intended strike is above or below its typical level over the past 30–60 days. This is called IV Rank or IV Percentile. Sensibull displays IV Rank prominently — if IV Rank is below 30%, the option is historically cheap (good buying environment). If IV Rank is above 70%, the option is historically expensive (consider reducing size, using spreads, or waiting for IV to normalise). This single check prevents the most common premium overpayment mistakes.