Term structure from zero

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Section 1

What is term structure?

Skew tells you how IV varies across strikes. Term structure tells you how IV varies across time — at a fixed strike (usually ATM).

Line up the ATM implied volatility for every expiry date available: 7-day, 14-day, 30-day, 90-day, and so on. The shape of that line is the term structure.

The term structure answers a simple question: when does the market expect risk to show up? Near-term? Far-term? Or is uncertainty spread evenly across time?

Analogy

Think of weather forecasts. Tomorrow's forecast is precise but might predict a storm. Next month's forecast is vague but calm on average. The term structure of weather uncertainty slopes upward with time — unless a hurricane is coming this week.

Section 2

Contango vs backwardation

There are two fundamental shapes. Contango is normal — far-term IV is higher than near-term. Backwardation is inverted — near-term IV is higher.

Contango (normal)

7d: 45% → 30d: 50% → 90d: 55%

Far-term IV exceeds near-term IV. Uncertainty accumulates over time. No near-term event is forcing vol higher. This is the default state.

Backwardation (inverted)

7d: 75% → 30d: 55% → 90d: 50%

Near-term IV exceeds far-term IV. Something is happening soon. The market is pricing event risk into the nearest expiries.

Why contango is "normal": More time = more uncertainty. A 90-day option has three months of possible surprises baked in. A 7-day option only prices the next week. In the absence of a specific near-term catalyst, far-term options should be more expensive (in IV terms).

Why backwardation signals danger: When near-term IV is higher, the market is saying "I expect something to happensoon that won't affect the long-term picture." It's a spotlight on imminent risk.

Section 3

Events and term structure

Events are the primary driver of term structure shape. Place an event in the explorer below and watch backwardation build.

Term Structure ExplorerContango

7d IV55.0%

30d IV63.7%

Spread (7d-30d)-8.7

Base IV: 55%Slope: Contango

Place an event

Toggle "Place an event" and set it near-term. Watch the curve invert around the event date. Expiries spanning the event pick up extra premium; expiries far beyond are barely affected.

Before the event: Options spanning the event trade at a premium. The term structure inverts around the event date. Near-term ATM vol spikes while far-term stays relatively stable.

Forward variance extraction

σ²_30→60 = (σ²₆₀ × 60 − σ²₃₀ × 30) / (60 − 30)

You can extract the implied vol for a specific future window from the term structure. If forward variance for a specific period is much higher than surrounding periods, there's likely an event in that window.

Section 4

Vol crush after events

After the event passes, near-term IV collapses. This is called vol crush — the event premium evaporates because the uncertainty has resolved.

Vol crush is the single most important dynamic to understand about term structure. If you buy near-term options before an event, you need the actual move to be bigger than what's priced in. Otherwise, even if you get the direction right, vega losses from vol crush eat your directional gains.

The sequence:

1. Event approaches → near-term IV rises → backwardation builds
2. Event happens → uncertainty resolves
3. Near-term IV collapses → term structure normalizes to contango
4. If you were long near-term options, vol crush hurts

Mean reversion model

σ(T) = σ_∞ + (σ₀ − σ_∞)e^−κT

σ_∞ = long-term average vol, σ₀ = current spot vol, κ = mean reversion speed. When σ₀ > σ_∞, the curve slopes down (contango) because the market expects vol to fall back to normal.

Trading implication

Calendar spreads are pure bets on term structure shape. Sell near-term (high IV), buy far-term (lower IV) when you expect vol crush. This profits when near-term IV collapses faster than far-term. But if the event produces a surprise and vol stays high, the near-term leg hurts.

Where to go next:

Skew — the strike dimension of volatility

Vol surface — combining term structure and skew

Term structure course lesson — the full course module