Persistent derivatives skew with open interest imbalance

Mechanism:

When open interest is lopsided (e.g., large net exposure concentrated among a small set of counterparties or strike ranges), liquidity providers and market makers are forced to hedge nonlinear exposures, which can mechanically translate into spot flows and adjustments to implied volatilities; this dynamic amplifies when gamma or convexity exposure must be dynamically managed around expiries or large moves, producing self-reinforcing feedback where hedging flows move the underlying and increase vol, requiring larger hedges.

Observable signals include persistent skew metrics, asymmetric term-structure moves, concentration metrics for open interest by maturity and strike, rising dealer hedging flows, and correlation between option expiries and spot volatility spikes.

For monitoring an instrument, such conditions increase the likelihood of rapid, flow-driven repricing events (e.g., squeezes, sharp vol mean-reverts, or localized liquidity stress) and complicate conventional hedging.

Practical responses include decomposing open interest by counterparty or venue where possible, stress-testing hedges under scenarios of aggressive hedger unwinding, and monitoring near-expiry gamma exposure alongside available market depth.

Risk managers should treat persistent skew plus concentrated OI as an elevated structural risk that can convert passive-looking positions into active drivers of price; it also signals environment where adding convexity protection or reducing directional exposure may be prudent.

Measurement toolkit:

Strike-by-strike open interest heatmaps, dealer flow proxies, skew and term-structure time-series, and cross-checks with funding and orderbook liquidity measures to assess whether hedging flows can be absorbed or will materially move the market.