Term Structure of Implied Volatility
The term structure of implied volatility described how implied volatility varied across different expiry dates for the same underlying and same strike, with a normal (upward-sloping) term structure showing higher IV for longer-dated options and an inverted (downward-sloping) term structure showing higher IV for near-dated options, typically during periods of acute near-term uncertainty.
Just as bond markets had a yield curve relating interest rates to maturities, options markets had a term structure relating implied volatility to expiry dates. For a given at-the-money strike on Nifty 50, the weekly expiry, the monthly expiry, and the three-month expiry typically implied different volatility levels. Under normal market conditions, longer-dated options carried higher IV than shorter-dated ones — reflecting the greater uncertainty over longer horizons and the higher likelihood of significant events occurring over a longer period. This upward-sloping configuration was the normal term structure.
Inversions in the term structure occurred when near-term uncertainty was exceptionally elevated. Before a critical scheduled event — a Union Budget, a US Federal Reserve policy decision, a general election result, or an RBI rate announcement — weekly or monthly Nifty options could price in much higher IV than quarterly options, because the market knew that a large move was likely in the immediate future. After the event passed and the outcome was known, near-dated IV collapsed rapidly, restoring a more normal term structure. India VIX, which measured the 30-day implied volatility of Nifty, reflected this dynamic: it spiked ahead of high-uncertainty events and fell sharply afterward.
Calendar spread traders specifically traded the term structure. A calendar spread involving selling a near-dated option and buying a far-dated option profited when the near-dated option's IV was elevated relative to the far-dated option — an inverted term structure. As the near-dated expiry approached and its IV normalised, the short leg became cheaper relative to the long leg, generating a profit. This was why experienced traders often entered calendar spreads specifically when the term structure was inverted.
The term structure also provided information for options strategy selection at different tenors. When far-dated IV was high (steeply upward-sloping term structure), selling longer-dated options collected richer absolute premium. When the term structure was flat or inverted, shorter-dated options offered comparable or better premium per unit of time, making weekly option writing more attractive on a theta-per-day basis.
For practitioners, tracking the term structure alongside the skew gave a more complete picture of the options market's risk distribution than any single IV number could provide. The combination of term structure and skew defined the full implied volatility surface — the three-dimensional landscape of IV across strikes and expiries — which was the fundamental input to sophisticated options pricing, hedging, and strategy selection.