As I have explained elsewhere, if the Black-Scholes model of options pricing did not make an incorrect assumption of log-normal distribution (bell curve) of price changes, then implied volatility (IV) skews found in equity index options, and many markets for equity options, largely would not exist (at least not as they do now).
In terms of horizontal skews, where option “mis-pricing” is across expiration dates, skew shapes similar to vertical skews can be detected. Just like vertical skews, horizontal skew shapes can look like “smiles” or “smirks” depending on prevailing conditions and built-in expectations in the marketplace. But their causes are of a different nature.
If implied volatility of a pair of option strikes with two different expiration dates is not the same, then this means that one or both option prices in the marketplace are deviating from model (or theoretical) prices. The degree of this intertemporal (across time) IV spread will determine the type and magnitude of the horizontal skew. A horizontal skew implies that the market is pricing a different level of volatility for options with different expiration dates.
-John Summa, PhD
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