Skip to main content

Lesson 7: Surface Dynamics

Promise: Understand how the vol surface moves as a whole, and what different movement patterns tell you.

The Surface is Alive​

So far we've looked at snapshots: skew at one moment, term structure at one moment. But the vol surface is constantly moving. Understanding how it moves is as important as understanding what it looks like.

Types of Surface Movements​

1. Parallel Shift (Level Change)​

The entire surface moves up or down uniformly. Drag the slider to see how the whole term structure shifts together:

Parallel Shift Demonstration

Before: ATM IV = 50%
→
After: ATM IV = 60%(+10)
40%50%60%70%80%7d30d60d90d180dTime to ExpiryATM IV
Before (baseline)
After shift
Key point: In a pure parallel shift, every strike and expiry moves by the same amount. The shape (skew, term structure) stays identical. Only the overall level changes. Risk-off → vol up everywhere.

What it means: Overall vol expectations changed, but relative structure stayed the same.

When it happens:

  • General risk-on/risk-off moves
  • VIX/DVOL level changes
  • Market uncertainty broadly increasing or decreasing

2. Skew Steepening/Flattening​

The tilt of the smile changes without the level moving much.

Movement
What Happens
Interpretation
Skew steepens
OTM puts get more expensive relative to calls
Increasing crash fear
Skew flattens
OTM puts cheapen relative to calls
Decreasing crash fear
Skew inverts
Calls become more expensive than puts
FOMO, short squeeze

3. Term Structure Rotation​

The slope across expiries changes.

Steepening (backwardation increases):

  • Near-term vol rises relative to far-term
  • Event risk is being priced in

Flattening (backwardation decreases):

  • Near-term vol falls relative to far-term
  • Event has passed, normalization

Inversion flip:

  • From contango to backwardation or vice versa
  • Significant regime change

4. Wing Expansion/Compression​

The curvature (butterfly) of the smile changes.

  • Wings expand: Both OTM puts and calls get more expensive. Tail risk demand increases.
  • Wings compress: Tails cheapen. Less fear of extreme moves.
💡

The surface doesn't just move up and down. It tilts, twists, and bends.

Spot-Vol Correlation​

One of the most important dynamics: how does vol respond to spot moves?

Negative Spot-Vol Correlation (Normal)​

When price drops, vol rises. When price rises, vol falls.

This is the typical pattern:

  • Selloffs are violent and scary (vol spikes)
  • Rallies are gradual and calm (vol falls)

Positive Spot-Vol Correlation (Unusual)​

When price rises, vol also rises. This happens in:

  • Parabolic rallies (everyone scrambling to buy calls)
  • Short squeezes
  • Late-stage crypto bull markets
Spot Move
Typical Vol Response
Unusual Response
Price drops 5%
Vol spikes 10-20%
Vol flat (complacency)
Price rises 5%
Vol drops 5-10%
Vol rises (FOMO)

Sticky Strike vs Sticky Delta​

How does the smile shift when spot moves? Two models:

Sticky Strike​

IV at each strike stays constant. The smile doesn't move when spot moves.

Implication: If spot drops, you're now closer to the high-IV part of the smile, so your ATM vol effectively increased.

Sticky Delta​

IV at each delta level stays constant. The smile shifts with spot.

Implication: If spot drops, the smile shifts left with it, so your ATM vol stays about the same.

Reality is somewhere in between, and varies by market and regime.

💡

In crypto, behavior is often closer to sticky strike, meaning spot moves amplify vol changes.

Surface Dynamics Around Events​

Pre-Event​

  • Term structure inverts (backwardation)
  • Overall level elevates
  • Skew may steepen as hedging increases

Post-Event​

  • Near-term vol collapses (vol crush)
  • Term structure often flips to contango
  • Skew may flatten if the event was benign
  • Skew may steepen further if the event was bad

The Vol Crush​

The most dramatic surface dynamic: post-event collapse of near-term IV.

Timing
7-day IV
30-day IV
2 days before FOMC
85%
62%
1 hour after FOMC
48%
55%

The 7-day IV collapsed 37 vol points. This is why buying options into events is often a losing strategy even if you're right on direction.

Multi-Factor Surface Models​

Professional traders think of surface moves in terms of factors:

  1. Level (parallel): Overall shift up/down
  2. Skew (tilt): Risk reversal changes
  3. Curvature (smile): Butterfly changes
  4. Term (rotation): Term structure slope changes

These factors are often partially correlated:

  • Level and skew tend to move together (vol up, skew steeper)
  • Curvature and level often move together (vol up, wings expand)

Trading Surface Dynamics​

If You Expect...
Consider...
Parallel shift up
Long straddles, long vega
Parallel shift down
Short straddles, short vega
Skew steepening
Long risk reversal (buy puts, sell calls)
Skew flattening
Short risk reversal (sell puts, buy calls)
Term structure flattening
Calendar spreads (sell near, buy far)
Wing expansion
Long butterfly/strangle

Common Mistakes​

MistakeCorrection
Only tracking vol level, ignoring shapeSkew and term structure dynamics matter for P&L.
Assuming negative spot-vol correlation always holdsIt can flip in bull markets.
Not anticipating vol crush around eventsThis destroys more long option positions than direction.
Ignoring sticky strike vs sticky deltaAffects how your delta hedges perform.

PCA (Principal Component Analysis) of vol surface moves typically shows:

  • PC1 (~70-80% of variance): Parallel shift (level)
  • PC2 (~10-15%): Term structure rotation
  • PC3 (~5-10%): Skew/tilt changes
  • PC4+: Higher-order (curvature, etc.)

This means most surface movement is simply "vol goes up" or "vol goes down," but the other components matter for relative value trades.

Traders often hedge each PC separately:

  • PC1: Long/short ATM straddles
  • PC2: Calendar spreads
  • PC3: Risk reversals

Test your understanding before moving on.

Q: What's a parallel shift in the vol surface?
Q: What typically happens to the vol surface after a major event passes?
Q: What is negative spot-vol correlation?

💡 Tip: Try answering each question yourself before revealing the answer.

See Also​

Navigation: ← Lesson 6: Vol Regimes | Lesson 8: Advanced Greeks →