Discipline Trading

Volatility Term Structure describes how implied volatility changes across different option expiries for the same underlying.

Simple Example

A possible curve might show:

•7D IV: 18%

•30D IV: 20%

•60D IV: 22%

•90D IV: 23%

Here, longer-dated IV is higher than near-term IV.

Why Does IV Differ Across Expiries?

Different expiries can price upcoming events, economic data, central-bank decisions, market uncertainty, supply and demand, and expectations about future volatility.

Contango

When longer-dated implied volatility is higher than shorter-dated IV, the volatility curve is commonly described as being in contango.

Backwardation

When shorter-dated IV is higher than longer-dated IV, the curve is commonly described as being in backwardation. This can occur when near-term stress or an event is being priced aggressively.

Term Structure vs Skew

Term structure compares IV across expiries. Volatility skew compares IV across strikes for a given expiry. They are different dimensions of the volatility surface.

Term Structure and Events

An expiry containing an important event can carry materially different IV from an expiry ending before that event. Event calendars therefore matter when interpreting unusual curves.

How Traders Can Analyse It

1.Identify the underlying.

2.Compare comparable strikes across expiries.

3.Record IV.

4.Observe the curve shape.

5.Check upcoming events.

6.Compare with recent history.

7.Examine skew separately.

8.Consider Vega and Theta.

9.Combine volatility information with price and risk management.

Common Mistakes

Do not treat an upward or downward curve as a directional signal, compare inconsistent strikes, or ignore event risk.

Final Thoughts

Volatility Term Structure helps traders understand how the market prices volatility across time. It complements IV Rank, IV Percentile, skew and the option Greeks.

Frequently Asked Questions

What is volatility term structure?

The relationship between implied volatility and expiry for a given underlying.

What is contango?

Generally, longer-dated IV is higher than shorter-dated IV.

What is backwardation?

Generally, shorter-dated IV is higher than longer-dated IV.

Does it predict market direction?

No.

Disclaimer

This article is for educational purposes only and does not constitute financial advice. Options trading involves substantial risk. Always understand the product, volatility, liquidity and applicable contract specifications before trading.