The term structure of skew refers to the relationship between the implied volatility skew of an option and its time to expiration, illustrating how the pricing disparity between out-of-the-money and in-the-money options varies across different maturity dates. Its primary purpose is to provide insights into market participants’ expectations regarding future asset price movements and potential tail risks over various horizons.
Mechanism
This phenomenon is observed through the analysis of volatility surfaces, where implied volatilities for options with the same underlying asset but different strikes and maturities are plotted. A typical “skew” implies that out-of-the-money puts trade at higher implied volatilities than out-of-the-money calls, and the “term structure” shows how this skew changes as options approach or recede from expiration, reflecting differing risk perceptions over time.
Methodology
The strategic application involves using this information to formulate options trading strategies, hedge portfolio risks, and identify potential mispricings across the volatility curve. Principles include adjusting option pricing models to account for the observed skew, designing calendar spreads or other multi-leg strategies that capitalize on anticipated shifts in the term structure, and managing exposure to volatility risk based on these temporal expectations, especially in dynamic crypto options markets.
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