Equity index options show higher implied volatility at low strikes while crude oil and natural gas frequently show the opposite. Explain both signs from the underlying economics, and say what each does to the price of a 25-delta risk reversal.

Equity index options show higher implied volatility at low strikes while crude oil and natural gas frequently show the opposite. Explain both signs from the underlying economics, and say what each does to the price of a 25-delta risk reversal.

Approach: Ask in each market which direction is the crowded hedge and which direction carries the supply shock, then map that demand onto the shape of the implied distribution.

Equity index skew is negative because index drawdowns are fast and correlated while commodity skew is often positive because the supply shock is to the upside. In equities the natural holder is long the asset and buys downside protection, correlation rises in a selloff so index volatility spikes exactly when the market falls, and the implied distribution carries a fat left tail. That bids low strikes and makes the 25-delta risk reversal trade with puts over calls, typically 4 to 8 volatility points in an index. In crude and natural gas the inventory constraint binds upward: a refinery outage or a cold snap can take price up several hundred percent while the downside is floored near the cost of storage, so calls carry the premium and the risk reversal flips sign. A trader who ports an equity skew intuition onto a gas book sells the wrong wing, and the loss arrives on the one week the weather turns.

Follow-up: Single stock skew is flatter than index skew at the same maturity. What does that gap say about implied correlation?

Key concepts: skew, risk reversal, crash risk, supply shock, implied distribution.