Horizontal Skew

Horizontal skew is an implied volatility skew on options where, for a given strike price, the implied volatility on an option will either increase or decrease as the expiration date moves forward into the future. Another form of volatility skew is vertical skew, which is the difference in implied volatility between out-of-the-money options, at-the-money options and in-the-money options, which provides information on whether options traders prefer to write calls or puts.

There are two types of horizontal skew:

1. Forward Horizontal skew: When the implied volatility of an option increases as the time to maturity increases.
2. Reverse Horizontal Skew: When the implied volatility of the option decreases as the time to expiration increases.

Implied volatility is derived from the Black-Scholes model that the market uses to price options. It shows where the market thinks volatility will be in the future. Intuitively, implied volatility might be expected to increase as the expiration moves into the future because of increased uncertainty, and with most options it does. However, reverse horizontal skew can and often does occur during news events such as earnings announcements. In cases such as these, many options will actually trade with a combination of forward and reverse skew similar to that of the vertical skew's volatility smile. This is because options that expire far in the future will always tend to trade with higher implied volatility than shorter term options, regardless of events happening in the near term.

For more on option volatility skews, read Option Volatility: Vertical Skews and Horizontal Skews.