Introductory Context
"The volatility smile shows IV plotted against strike prices — creating a characteristic shape. In Indian index options, the smile is asymmetric (a volatility skew or smirk): OTM puts have higher IV than OTM calls, reflecting institutional demand for downside protection and the market's recognition of asymmetric tail risk. "
What the Smile Looks Like in Indian Markets
Plot the implied volatility for every available Nifty strike on expiry day against the strike price and you get the volatility smile. For Indian Nifty index options on a typical day:
• IV 20–25% — highest in the chain: Deep OTM puts (25,000+ points below spot).
• IV 16–18%: OTM puts (500 points below spot).
• IV 13–15% — the trough of the smile: ATM put/call.
• IV 13–15% — roughly similar to ATM: OTM calls (500 points above spot).
• IV 14–17% — modestly elevated but well below deep OTM put IV: Deep OTM calls (1,000+ points above spot).
The pattern is asymmetric — a true 'smirk' rather than a symmetric smile. The left side (OTM puts) has dramatically higher IV than the right side (OTM calls). This asymmetry is the defining characteristic of index options in most markets globally, and it is particularly pronounced in Indian index options.
The Smirk vs The Smile
A true volatility smile is symmetric — OTM puts and OTM calls at equal distances from ATM have the same IV. A symmetric smile would exist if the market feared equally large upside and downside moves. The volatility smirk (or skew) is asymmetric — OTM puts have higher IV than OTM calls. The smirk reflects the market's recognition that sharp downside moves are both more feared and historically more frequent than sharp upside moves of equivalent magnitude.
Why the Skew Exists — Three Explanations
Explanation 1: Portfolio Insurance Demand
The most direct explanation: institutional investors systematically buy OTM puts to protect equity portfolios from large declines. This buying demand is persistent — it occurs in every market condition regardless of the current directional view. Portfolio managers do not buy put protection because they are bearish; they buy it because they have fiduciary obligations to protect against catastrophic downside. This systematic demand for OTM puts pushes OTM put prices — and therefore OTM put IV — above what a symmetric distribution would imply.
Explanation 2: Fat Tails and Asymmetric Crashes
History shows that equity market crashes are faster and more severe than rallies of equivalent magnitude. Markets typically take months to rise 30% and weeks to fall 30%. This empirical asymmetry means the market rationally prices larger tail risk on the downside than on the upside — which manifests as higher OTM put IV compared to OTM call IV.
Explanation 3: Supply and Demand for OTM Calls
OTM calls are routinely sold by covered call writers (investors who own stocks and sell calls against them for income). This structural supply of OTM calls keeps their prices — and therefore their IV — lower than OTM puts, where there is no equivalent systematic seller supply.
How to Use the Skew in Trade Decisions
Comparing OTM Puts vs OTM Calls — The Relative Pricing Insight
Because OTM puts consistently have higher IV than equidistant OTM calls, put buyers systematically pay more for equivalent strike-distance exposure than call buyers. An OTM put 300 points below spot costs more than an OTM call 300 points above spot — not because the directional probability differs significantly (it depends on market conditions) but because of the structural premium demand for puts.
Practical implication: if you are choosing between buying an OTM put or an OTM call with similar expected probability of success, the call is typically cheaper in premium terms due to lower IV. This cost difference should factor into strategy selection when direction is genuinely uncertain.
Skew as a Sentiment Gauge
The steepness of the skew changes with market sentiment. A steeper-than-normal skew (OTM put IV much higher than OTM call IV) indicates elevated fear — the market is paying a significant premium for downside protection. A flat or narrowing skew (OTM put IV approaching OTM call IV) suggests complacency or balanced two-directional uncertainty — as seen immediately before major events where the market genuinely does not know which way things will go.
Reading Skew Changes
Compare the skew at the start of the week to mid-week. If the skew is steepening (OTM put IV rising faster than OTM call IV), there is increasing institutional hedging demand — potentially a warning signal of building institutional bearishness. If the skew is flattening, institutional hedging demand may be easing — a modestly bullish signal. Skew changes are available on Sensibull and Opstra through their volatility analysis views.