Volatility Term Structure

The volatility term structure shows implied volatility across different expiration dates for the same underlying, usually at the money. Its shape tells you how the market expects volatility to evolve: whether today's conditions are calmer or more turbulent than normal, and whether specific events are coming. Traders use it to choose expiries, to spot events priced into specific dates and to trade calendar spreads and VIX futures.

The two main shapes#

Equity index term structures slope upward most of the time and invert during selloffs. Because implied volatility tends to revert towards its long run average, short dated volatility moves much more than long dated volatility. See Mean Reversion.

Events in the term structure#

Scheduled events add extra expected movement on specific dates, creating bumps in the term structure.

Similar bumps appear around central bank meetings, elections and economic releases. See Trading Economic Releases.

VIX futures term structure#

VIX futures for successive months form their own term structure. In calm markets they slope upward (contango), so long VIX positions lose as futures roll down towards the lower spot VIX. In panics, the curve inverts, and short VIX positions suffer. The ratio of VIX to VIX3M (3 month volatility index) is a common gauge: above 1 signals inversion and stress. See The VIX and Contango.

How traders use the term structure#

• Choose expiries: selling short dated options when the curve is inverted collects rich premium, but at peak risk.
• Calendar spreads: sell the expiry with high IV, buy the one with low IV. See Calendar Spreads.
• Event trading: isolate the volatility of a specific event.
• Regime signals: an inverted curve is a sign of stress; a return to contango often accompanies recovery.
• Term structure trades: bets on the slope steepening or flattening. See Term Structure Trading.

Why long dated volatility is stable#

Long dated implied volatility reflects average volatility over a long period, which includes calm and stressed times. A short term shock barely changes the average, so long dated volatility moves less. Models such as Heston capture this with mean reversion. See Stochastic Volatility and the Heston Model.

Common mistakes#

• Comparing IV across expiries without considering events.
• Assuming contango makes short VIX products safe; inversions can be sudden and severe.
• Treating vega as equal across expiries, when short dated volatility moves more.

Frequently asked questions#

What is the volatility term structure?#

The pattern of implied volatility across different expiration dates for the same underlying.

What does an inverted volatility term structure mean?#

Short dated implied volatility is higher than long dated, usually during market stress when traders expect turbulence to fade over time.

How can I see an earnings move in the term structure?#

Compare implied variance for expiries before and after the earnings date; the extra variance in the later expiry reflects the expected earnings move.

Next, learn how the whole surface moves in Volatility Surface Dynamics.