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:
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:
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.
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
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
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 |
💡 Tip: Try answering each question yourself before revealing the answer.
See Also
Navigation: ← Lesson 2: Skew | Lesson 4: The Vol Surface →