I still am very intrigued by the volatility skew. In theory the implied volatility is distributed uniformly across various option strike prices. As investors become more concerned about larger equity moves they will begin buying more out of the money puts for downside protection and or speculative plays. This causes the volatility distribution to not look like smile, hence the name "volatility smile." Instead it is "skewed" more towards the out of the money puts and less towards the OTM calls.

In essence it gives you a sense of fear in the market not captured by the VIX. Below are the two updated charts I show regularly with a few highlights.

Skew VS Vix

The skew peaked on 4/20/10 about two months before the end of QE1. Interestingly it peaked again on 4/21/11 about two months before the end of QE2.

Most recently the skew has moved up very significantly while the vix continues to flat line. Fear and or speculation of a big equity move is clearly being shown in the skew as the divergence of the two (skew and vix) refuses to come down. Historically such divergences have preceded a down move in equities.

Skew & Vix Divergence VS SPX

The divergence (skew and vix) peaks prior to the peak in equities.

Notice the correlation with the divergence and the interim top in equities on 4/20/10 and 2/18/11. The most recent divergence high on 4/21/11 has also preceded the 5/2/11 high in equities.