Horizontal Skew

Posted in Finance, Accounting and Economics Terms, Total Reads: 459
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Definition: Horizontal Skew

Implied volatility levels for each strike prices are not the same and there are patterns to this IV variability. Thus there is a difference in implied volatility when different options with same strike price but different time to expiration. Horizontal skew refers to the property of an option that its implied volatility will move in either direction as the option moves more into the future.


There are two types of horizontal skew:

1. Forward Horizontal skew: When the implied volatility of an option increases with increase in time to maturity, it is called forward horizontal skew

2. Reverse Horizontal Skew: When the implied volatility of the option decreases with increase in time to maturity, it is called Reverse Horizontal Skew.


Generally, a longer term options generally trade with higher implied volatilities than do shorter terms. However there are situations when shorter term options show higher volatility than a longer term option. Thus reverse horizontal skew does exists specially when a critical event occurs like earning announcements, etc.

 


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