How Do Options Market Makers Use Volatility Skew to Price and Manage Their Derivatives Risk?

Volatility skew, or smile, refers to the phenomenon where options with the same expiration but different strike prices have different implied volatilities. Market makers use this curve to accurately price options across the strike range.

Managing risk involves hedging the 'vega' (volatility risk) and 'delta' (directional risk) of their entire portfolio based on the shape and movement of the skew.