MenthorQ Skew and Term Structure Lesson

This lesson introduces powerful new features we’ve added to MenthorQ: term structure charts and skew analysis, including the ability to view past term structure overlays. You’ll learn how combining these two tools helps you identify where options are relatively cheap or expensive across the entire volatility surface, giving you a critical edge in options trading decisions.

The term structure chart now displays current levels compared to yesterday, five days ago, and 30 days ago, allowing you to track how the market is shifting toward contango or backwardation. When you see an upward sloping term structure (contango), it signals that short-term implied volatility is low but market makers expect higher volatility in longer-dated options. This pattern tells you that buying short-dated options will be cheaper, while selling long-dated options will command higher premiums.

The skew chart reveals the relative pricing between puts and calls at different strike prices. When combined with term structure, you can craft sophisticated strategies tailored to your market outlook. For example, when Nvidia’s put skew showed puts at the top of their range (relatively expensive), bullish traders could sell those expensive puts for income or create favorable risk-reward setups by selling puts and buying cheaper calls for leveraged exposure.

Even if you’re strictly a technical trader who doesn’t trade options, skew analysis provides valuable insights into market sentiment and potential price action. When the put skew shifts dramatically—indicating the market is pricing more symmetrical risk rather than predominantly upside moves—you might adjust your take-profit targets accordingly, recognizing that explosive moves could now happen in either direction rather than just upward.

Video Chapters

00:00 – Introduction to term structure and past term structure overlays
01:55 – Understanding contango and upward sloping term structure
03:12 – Combining skew and term structure for Nvidia analysis
04:27 – Bullish and bearish option strategies using skew
05:34 – Using skew insights for technical trading decisions

Key Takeaways

Term structure combined with skew reveals where options are relatively cheap or expensive across the volatility surface
Past term structure overlays (yesterday, 5 days, 30 days) help you identify shifting market dynamics toward contango or backwardation
When put skew is elevated, consider selling expensive puts for bullish exposure or creating favorable put spreads using in-the-money puts
Even technical traders can use skew to gauge market sentiment and adjust profit targets based on whether volatility risk is symmetrical or directional

Video Transcription

[00:00:00.12] - Speaker 1
So first we have a simple, before.

[00:00:02.10] - Speaker 2
We go into that, also one thing that we are introducing that is new is the term structure. So we've added a new chart and we also added past term structure. So you can see the term structure today versus yesterday, five days ago and 30 days ago. So that can give you like a good understanding if the market is changing. You know, the term structure is shifting, moving towards contango, backwardation and so on. And how can that be leveraged? So yeah, yeah.

[00:00:32.09] - Speaker 1
And so really those two things combined, term structure plus skew, it really helps us think about where options are relatively cheap and rich. As traders, we always try to have this idea of, you know, what's fair value and then what's relatively cheap, what's relatively expensive right now, particularly when you're a market maker. And so together that gives the SKU and the term structure give you the whole sense of, hey, if I want to buy options, I want to go find where I think the relatively cheapest place to buy options is in the, you know, in the volatility surface using both term structure and skew. You know, I want to sell options, you know, vice versa. Then I want to find the most expensive implied volatility to sell. So right now, looking at term structure, we can see a pretty consistent stock story over the last day or so. You know, things have kind of become more middling. You know, there's not a strong signal from this. But I'm going to just focus on actually where we were about a day ago, the red line, the red dotted line down there. So, you know, when markets, when markets have periods of really low realized volatility, but market makers, you know, don't want to basically sell, sell longer dated options too cheap because they're concerned about a big spike.

[00:01:55.18] - Speaker 1
We start to see what we saw in the last couple days, which was this big, sometimes called contango, but an upward sloping term structure. So you could see that and we saw that across the board we were seeing these kind of really low short term implied volatilities that were going up over time. So again, the market's telling us that, hey, volatility is really low right now, but it's not gonna, not necessarily gonna stay that way. And as we go further out on the expiration timeline, then we're going to start to see implied volatility go, go up. And so again, if we're, if we're thinking about buying options, you know, typically we're going to get options much cheaper if we buy the very short dated stuff. And if we want to, you know, get higher prices for the options we sell, we're going to want long dated.

[00:02:46.15] - Speaker 2
I think now, Ryan, if you know, like how can we combine and you know, we're just going to do with this one last example, but then we also have a session on July 24th just to specifically talk about skews. But here you see obviously two charts which is the at the money term structure and the SKU 3 months SKU for Nvidia. So how can you actually use this chart and what can you derive from it?

[00:03:12.14] - Speaker 1
Yeah, absolutely. So, so taking a look at Nvidia. So what can we see here? So when we look at the sku, what we can see is that after a brief dip, the puts have gotten really expensive on Nvidia over the, you know, over the time period that's in question or at least relatively expensive compared to they're, they're at the top end of the range. So, you know, not a great time to be buying puts as a trader. So there's a few different strategies that we can look at here. So kind of beginning level bull strategy. And again, you know, I want to emphasize that these markets don't necessarily tell you that there's one trade, but depending on what your basic outlook is on the market, you can almost always find an option structure from the SKU that'll support your position. So for example, if you're bullish Nvidia, what, what can you do with this? Well, when you know, puts are relatively high, it might be a good time to actually sell puts to get exposure to Nvidia. You get a long, you know, effectively a long bias by selling those, those relatively expensive puts. And you could also sell the puts and buy the calls, you know, if you wanted to get some leverage.

[00:04:27.22] - Speaker 1
So you might be able to get cheaper leverage if you wanted to do, you know, basically get more exposure to Nvidia than you would otherwise by selling puts and buying calls. And you could probably do that more basically more times than you'd feel comfortable buying underlying contracts. Plus that would help insulate you from some of the noise and the short term choppiness if you just want it to be exposed for the big moves. But let's say you're bearish. This is a little bit more advanced strategy, but knowing that the put skew is the way it is. So those out of the money puts are going to be much more expensive and the calls are going to be relatively cheaper. We could look at buying it in the money put which will actually use the. This is A bit, bit more advanced, but uses the implied volatility from the calls because it's in the money and we can look at buying it in the money put and selling it out of the money put. And so basically creating a put spread. But a put spread that's favorable to us because the put that we're selling is, is going to be higher implied volatility.

[00:05:34.05] - Speaker 1
So we'll collect relative, relatively more premium. We will have to pay a premium to buy this put spread. But it should be relatively cheap to express a fairest view on Nvidia and probably a lot safer than say shorting the stock. What if you're just a technical trader and you're not here to trade options at all? What can we say from this? You know, I think, I think you can actually get a lot out of these SKUs, which is why I'm guessing this is such a popular request. You know, if, if I'm trading Nvidia right now and I was long, I would personally be lowering my kind of take profit targets. And the reason being is that the market does not seem to be pricing in the, the risk of the, of a huge spike, you know, a hugely volatile spike. I know that's been happening for an Nvidia for, you know, a while now, but it seems like the market's starting to say that the risk is becoming a bit more symmetrical. So after previously being a stock where the kind of explosive movement was to the upside, it seems that now the market's saying, well, you know, it could be pretty explosive up or down now, you know, suggesting Nvidia has become at least a bit more fairly priced.

[00:06:44.15] - Speaker 1
So if I was, if I was, you know, long Nvidia and working some take profit targets, I would probably tighten those up. I wouldn't be quite as aggressive or ambitious thinking oh, you know, this thing's going to go to the moon. I'd be, I'd be in and out quicker because you gotta, you gotta increase the, the kind of probability of a downside sell off relative to the rally.