What is Volatility Term Structure?
Volatility term structure is the implied vol of a fixed-moneyness option plotted across expiries. It is "upward sloping" (contango) in calm markets and "inverted" (backwardation) in stress.
Definition
Term structure is the slice of the vol surface obtained by fixing moneyness — usually ATM — and varying time to expiry. In a calm market, the curve slopes upward: short-dated vol is low, long-dated vol is higher (because uncertainty compounds over time and there is more demand for short-dated vol selling than for long-dated). This is "contango." In a stressed market, short-dated vol explodes above long-dated vol — the curve inverts, called "backwardation," and the market is pricing immediate fear. The slope and curvature of the term structure are tradable: calendar spreads, diagonal spreads, and term-structure trades like long front-month / short back-month variance swaps express views on the curve's evolution without taking pure directional vol risk.
Why it matters & how it's calculated
Term structure is best analysed in "total variance" space (σ² × T) rather than raw IV — that's the space in which arbitrage constraints (calendar non-arbitrage) take a clean form: total variance must be monotonically non-decreasing in T for each strike. Common quantitative metrics include the "VIX9D / VIX" ratio (very short-dated vs 30-day) and the "VIX / VIX3M" ratio (30-day vs 90-day) — when these ratios spike above 1.0, the curve is inverted and short vol selling becomes dangerous. The forward variance implied by two expiries (Var_T2·T2 − Var_T1·T1) / (T2−T1) tells you what the market is pricing for the period between them — this is the price of forward vol, and forward-vol trades (long T2 short T1) are pure exposure to changes in that forward number. Term structure also has predictable seasonality: index vol has small Fed/CPI/earnings bumps in specific expiries that show up in the curve as "spikes" that can be cleanly traded around.
Worked example
30-day SPX ATM IV at 14%, 90-day at 16%, 180-day at 17.5%. Upward-sloping, classic contango. Now imagine an FOMC week: 30-day jumps to 19%, 90-day stays at 16%, 180-day drops to 16.5%. Curve is humped at the FOMC tenor, inverted across the rest. Trading this means selling the front bump and buying the back, betting the FOMC-week premium will collapse after the event.
Related concepts
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