Lesson 3: Term Structure

Promise: Understand why near-term and far-term volatility differ, and what the shape of the term structure reveals about event risk.

What is Term Structure?

Term structure describes how implied volatility changes across expiries at a fixed strike.

Take ATM options across different expiries:

Expiry

Days

ATM IV

Weekly

7

72%

Monthly

30

58%

Quarterly

90

52%

6-month

180

48%

This downward slope (near-term IV > far-term IV) is called backwardation or an inverted term structure.

Contango vs Backwardation

The term structure has two main shapes. Toggle between them to see how IV changes across expiries:

Far-term IV > Near-term IV

No immediate event risk. Uncertainty accumulates over time. Near-term options are relatively cheap.

Contango = Normal

Backwardation = Event Risk

💡

Backwardation screams: "Something's about to happen."

See It In Action

Toggle between the three main term structure shapes:

Term Structure

Backwardation: Near-term IV > far-term. Signals event risk priced in.

Toggle between shapes to see how term structure changes. Backwardation often signals an upcoming event.

Why Term Structure Changes

Event Pricing

The most common cause of backwardation: a known event is approaching.

Event Type

Effect on Term Structure

FOMC meeting

Options expiring around the meeting get bid up

ETH merge/upgrade

Near-term IV spikes, far-term less affected

BTC halving

Months of elevated term structure leading up

Earnings (stocks)

Classic event: IV spikes pre-earnings, crashes after

Realized Vol Feedback

If the market is currently volatile (high realized vol), near-term IV rises to match. Far-term is less reactive.

Mean Reversion Expectations

Vol tends to mean-revert. If current vol is high, the market expects it to normalize, so far-term IV stays lower. If current vol is low, far-term may be higher.

Reading Term Structure

Shape

What It Tells You

Trading Implication

Steep contango

Calm now, uncertainty later

Near-term options are cheap

Flat

Balanced expectations

No strong view priced in

Mild backwardation

Some near-term concern

Near-term premium elevated

Steep backwardation

Major event imminent

Near-term very expensive

Example: Pre-FOMC Term Structure

Two days before a major Fed meeting:

2-day options: 85% IV
7-day options: 70% IV
30-day options: 55% IV

The market is pricing a big move around the announcement. After the event, near-term IV collapses (vol crush), and the term structure often flips to contango.

Term Structure and Calendar Spreads

Understanding term structure is essential for calendar spreads:

Sell near-term, buy far-term: Profits if term structure steepens (more backwardated) or near-term IV drops faster
Buy near-term, sell far-term: Profits if term structure flattens or inverts further

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Calendar spreads are bets on term structure shape changes.

Crypto Term Structure Patterns

Crypto term structure has unique characteristics:

Pattern	Description
Volatile baseline	Even "calm" periods have 50%+ IV
Fast normalization	After events, term structure snaps back quickly
Weekend effects	Sometimes visible in very short-term options
Correlation with BTC	Alt term structures often follow BTC's lead

Common Mistakes

Mistake	Correction
Ignoring event calendars	Always check what events fall within your option's life
Buying expensive near-term pre-event	You're paying for event premium that will evaporate
Assuming term structure is stable	It shifts constantly, especially around events
Not understanding vol crush	Post-event IV collapse can overwhelm directional gains

Term structure is often analyzed in variance space rather than volatility:

Forward Variance

FwdVar_t₁→t₂ = (σ²_t₂ × t₂ − σ²_t₁ × t₁) / (t₂ − t₁)

Hover to explore:

Hover over a variable above to see its meaning.

Key Insight

If forward variance is much higher than current variance, the market expects a vol spike in that window (e.g., an event). This is why we analyze term structure in variance space.

Variance is additive over time (under certain assumptions), which makes it mathematically cleaner for term structure analysis.

Test your understanding before moving on.

Q: What does backwardation in vol term structure indicate?

Q: Why would near-term options become expensive before a Fed meeting?

Q: What happens to term structure after a major event passes?

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

What is Term Structure?​

Contango vs Backwardation​

See It In Action​

Term Structure

Why Term Structure Changes​

Event Pricing​

Realized Vol Feedback​

Mean Reversion Expectations​

Reading Term Structure​

Example: Pre-FOMC Term Structure​

Term Structure and Calendar Spreads​

Crypto Term Structure Patterns​

Common Mistakes​