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Volatility Term Structure: Implied Volatility by Expiration
The volatility term structure is implied volatility for one stock laid out across its expirations. Its shape tells you when the options market expects the stock to move, and by roughly how much.
DefinitionSeen on: Option chain
Volatility term structure The pattern of implied volatility across the expiration dates of one underlying's options, usually read as a curve from the nearest expiration to the furthest.
Also called IV term structure, volatility curve by expiration.
Open the option chain for a hypothetical $100 stock and read the at-the-money implied volatility in each expiration tab. The 7-day options show 60%. The 30-day options show 35%. The 90-day options show 30%, and if you plot those numbers against days to expiration you get a term structure that slopes steeply down from left to right, the shape a chain takes when something is sitting in the front week.
Why the front is so high here
The company reports earnings in four days. The 7-day expiration is the shortest one still alive on report day, so its premium carries the whole expected jump, spread across only a handful of trading days. Annualize that and the figure balloons. The 30-day options also span the report. They dilute it across more ordinary days, and the 90-day options dilute it further.
In calm periods with no event on the calendar the curve usually slopes the other way, rising gently with time, because more time gives more room for something to happen. Stress flips it. In a sharp sell-off, traders pay up for short-dated protection.
Turning the numbers into a move
Implied volatility is an annual figure. Scale it by the square root of the fraction of a year left.
The 7-day options price in a move of about $8.31 within a week. The 30-day options expect only about $10.03 across a whole month. The 90-day options, covering three months, expect about $14.90, less than half as much again as the 30-day figure.
Most of the month’s expected movement, in other words, sits in the few days around the report, and that’s the event premium made visible: remove the earnings date and the 7-day figure would likely sit near or below the 30-day one. The lesson on the earnings implied move gets there from the straddle price.
The earnings kink
Chart the whole curve and an earnings date shows up as a kink. The expiration just after the report stands above its neighbors. After the report, the premium drains out of the front expiration almost at once. Traders call that the volatility crush.
Where you see it on a screen
Most option chains show IV per strike inside each expiration. Many add a summary figure. Some platforms plot the curve for you, and if yours doesn’t, jot down the at-the-money IV for each expiration in order and read the slope yourself. Compare today’s curve with its usual shape. A stock whose front month normally trades a few points below the back month, and now trades well above it, is telling you an event is priced.
Check again the day after the report. The front of the curve usually drops back toward the rest once the event premium drains, and the new shape shows whether the market still expects unusual movement or has settled back into its usual gentle upward slope.
Trading the slope
Calendar spreads and diagonal spreads are the usual ways to trade the shape. Both sell a nearer expiration and buy a later one. The case that calendar spreads are a bet on volatility explains why the result depends more on how the curve changes than on where the stock goes, since the spread collects the rich front-month premium while holding the cheaper back month, and it spells out the risk: a drop in back-month IV cuts the value of the long leg, which is the more expensive of the two.
What people get wrong
Some read a high front-month IV as a call on direction. IV says nothing about up or down.
A second mistake is comparing IV across expirations without adjusting for time. The 60% on the 7-day options looks close to double the 35% on the 30-day options, yet the dollar move it implies is smaller.
Last, people sell the inflated front month and forget the event is still ahead. The high IV is high for a reason. If the report produces a move bigger than the one priced in, the short option loses. The course on earnings reactions covers how report-day moves compare with what options price in.
Related terms
Implied volatility and the expected move sit closest to this idea. More in the options hub.
People also ask
What does an inverted volatility term structure mean?
It means nearer expirations carry higher implied volatility than later ones. That usually happens when the market expects a large move soon, such as an earnings report inside the front expiration, or during a sell-off when traders pay up for short-dated protection. Once the event passes, the front of the curve typically falls back toward the rest.
Why does the expiration right after earnings have higher implied volatility?
Its price has to cover the report. The expected jump on report day is packed into the options that are still alive when it happens, and the fewer other trading days that expiration contains, the higher the annualized figure looks. Expirations further out spread the same event across more days, so their IV rises by less.