How to use Term Structure and SKEW Lesson

In this lesson, you’ll learn how to interpret two critical options market indicators: term structure and skew. These tools help you understand what the market is expecting in terms of price movement and volatility, even if you never trade options yourself.

Term structure shows at the money volatility across different time periods to expiration. You’ll see how implied volatility can range dramatically—in the example shown, it moves from 55 down to 45, then back up to 60—revealing how the market expects movement to vary over time. When markets are calm and rallying, you’ll typically see an upward sloping structure, which tells you that while things are quiet now, market makers expect volatility to eventually return to normal levels.

The term structure also reveals important events on the horizon. In the lesson example, you can see a spike around the one-month mark indicating the market is pricing in potential volatility from an upcoming earnings announcement. The front end of the curve provides the most actionable information about near-term expectations, while the long end (60 to 80 days) shows more permanent shifts in market sentiment. When you see that longer-dated portion moving significantly up or down, it signals the market expects a more seismic shift rather than temporary conditions.

Skew demonstrates how implied volatility changes across different strike prices. Rather than being a fixed number, volatility gets much higher as you move further from the current price—what the lesson calls “the wings.” Using Nvidia trading around 888 as an example, implied volatility increases substantially at strikes way down at 600 or way up at 1200. This happens because nobody wants to sell “lottery tickets” or extreme bets against crazy events, since those events can and do happen. The shape of skew also tells you what the market expects at different price levels—for instance, continued volatility during a bull run, declining volatility if prices settle to a lower range, or dramatically increased volatility in a collapse scenario.

Video Chapters

00:00 – Introduction to at the money volatility and term structure
00:40 – Reading market conditions from the term structure curve
01:30 – Identifying earnings events and short-term volatility spikes
02:29 – Understanding long-term versus front-end curve movements
03:38 – Introduction to skew and fat tails
04:49 – How skew changes across strike prices and market scenarios

Key Takeaways

Term structure shows at the money implied volatility across different expiration dates, revealing how market expectations change over time
An upward sloping structure typically indicates calm current conditions with expectations of returning to normal volatility levels
Skew demonstrates that implied volatility isn’t constant but increases substantially at strike prices far from current levels
The front end of the curve provides actionable near-term information, while the long end (60 to 80 days) signals more permanent market sentiment shifts

Video Transcription

[00:00:01.11] - Speaker 1
Yeah, so first we just look at, at the money volatility. We call this the term structure. So this is just looking at the time component because even, you know, professional traders tend not to use like a 3D surface. It's kind of hard to wrap your head around. So this one's very straightforward.

[00:00:15.04] - Speaker 1
Right. So just for an at the money option, you know, what is the implied volatility? And you can see that depending on how much time we have to expiry, that number changes quite a bit. The implied volatility goes from 55 all the way down to 45, back up to a high of 60. And this is the market's way of telling us, you know, how much we can expect movement of the underlying security to vary over time.

[00:00:40.18] - Speaker 1
And there's a few good things you can see here. So, you know, take that blue dotted line from one month ago. Whenever you have real slow, quiet times like we, we were having, although it seems like we're starting to get a pickup. When markets are rallying and things are good, you tend to see things get calm, daily moves get small. And in that scenario, you know, options start to get cheaper and cheaper.

[00:01:05.05] - Speaker 1
But you know, market makers are not dummies, you know, they're not. That doesn't mean that, that it's going to stay calm with small moves forever. So you'll often see this, this upward sloping structure that Fabio is pointing to here of that blue line. You can see that it's sloping upward, you know, over time. And what that's telling you is, hey, things are quiet right now, but eventually it's going to kind of return to a more normal level.

[00:01:30.28] - Speaker 1
Then, you know, we get this. Now looking at the green line, the current value, what we can see is we're having a little pop right now. Suddenly, you know, there's been a little bit more volatility, a quick sell off some concerns, some, some earnings problems for a few of the big tech stocks and suddenly there's a little bit of a spike in the short term volatility. But you know, that it doesn't seem to be a permanent feature yet. But then suddenly see this big spike.

[00:01:57.04] - Speaker 1
Well, that's the market adjusting for earnings announcements, right? So we've got earnings coming out in about a month here. And again, market makers are dummies. You know, the market is pretty efficient and so it realizes obviously that we'll get a big spike in volatility potentially around, around earnings announcement, and then it'll start to decline right back to that kind of long term norm. You can See that in all these examples, the long term, long term kind of normal expectation of volatility doesn't change a whole lot, but the front end of the curve can tell us a whole lot.

[00:02:29.21] - Speaker 1
So we can use that and we can. And again, going back to why this is important, even if you have no goals to be a complex options trader or trade, implied volatility, you can really see what the market is, is telling you and translated into words. So you can say, you know, you know, you can look at that blue line and say, ah, like you know, things are quiet right now, but don't expect it to continue. And then when you look at the green line, okay, we've gotten a little pickup, but it's not permanent except for of course, when earnings come out in a month and then we think we should get back to more normal, period. Whereas if you see that long end of the curve, by the long end of the curve I mean that 60 to 80 days, if you see that yellow line is for an example shifting up or the blue line shifting down, those are more permanent changes people.

[00:03:15.25] - Speaker 1
The market's actually starting to tell you, oh, we think there could be a more, you know, seismic shift involved when you see that into the curve move. So, you know, you can really make informed statements about at least market's expectations. Obviously expectations can and do change. But, but that's the first thing implied volatility tells you. Next slide.

[00:03:38.03] - Speaker 1
Next. The other, the other side of the coin is, is skew or taking into account that implied volatility isn't constant, you know, for a given price. So what's going on here? So this is what I was talking about, fat tails, right? Things can move much further out than you know, just a single implied volatility number can capture.

[00:04:03.16] - Speaker 1
And so you tend to see that implied volatility gets really high the further you move when you get really far from the strike price. So this orange line is showing you that when you know, when in video is around 888, 88, I can't that, you know, if you went way down to like 600, you start to get much higher implied volatility. And when you go way up to 1200 again, you start to get really high implied volatility. And what that's telling you is that nobody wants to sell what we call lottery tickets or teaming options. Basically bets against, you know, against a crazy event because crazy events can and do happen.

[00:04:49.29] - Speaker 1
And so the implied volatility is typically higher out there on what we call the wings. And then you also typically see well. And then for any given stock, you know, the shape of this will change a little bit. And even for a single stock, it'll change over time. But the key here to take away is that volatility isn't again, it's not just a fixed number, like on the last slide I showed you, that it changes over time.

[00:05:13.21] - Speaker 1
This also shows you that it changes over price. So here the market thinks as long as this kind of bull run continues for Nvidia, it's going to just continue to chop around. It's going to be pretty volatile. But if, if the kind of earnings excitement ends and it settles back down to the 750 to 800 range, then we might expect volatility to decline pretty substantially, with the caveat that if we have a price collapse, maybe a bigger market collapse or something, then volatility could really pick up again. So it's it's pretty nuanced.