Horizontal Skew or Time Skew refers to the difference in implied volatility across options with different expiration dates (or different maturities) but have the same strike price.
Usually longer-term options trade with lower implied volatilities than do short-term options.
Time Skew normally occurs when the market expects an extraordinary event to occur in a particular week or month, e.g. earnings announcement.
Usually, options with near-term expirations will have higher implied volatility than options with longer term expirations.
What is Term Structure of Volatility?
The term structure of volatility is a way to view the horizontal skew of options. It shows how the implied volatility for at-the-money (ATM) options will change over time with the maturity date of the option.
The term structure is generally represented as a list or curve and helps traders and investors judge easily whether the price of the option will change in the future.
There are three possible curves or term structures:
- Upward Sloping (rising term structure) – Longer-term options have more implied volatility than near-term options.
This is similar to “contango” in the futures market. - Downward Sloping (falling term structure) – Longer-term options have less implied volatility than near-term options.
This is similar to “backwardation” in the futures market. - Flat – Longer-term options have approximately the same implied volatility than near-term options.
