the inverted term structure trap

It started with Benn’s observation:

What do you think about crude with something like this? Would you be something like long vega vs long deltas rolling up the curve? idk what even would be optimal to exploit a term like that due to the gamma problem.

My response:

It all depends on context. For example, if you saw my post today, I actually thought April 11 vol was too cheap relative to expiries behind it.

The curves are useful because they allow you to compare across timeframes, but nothing about the curve itself necessarily indicates a trade. Optically, the fronts may look high—but as we’ve seen, they’ve been cheap. And part of the reason they might be cheap is that people naively think they’re too high and sell them.

So it’s less about the shape of the curve and more about reasoning through the assumptions that might be causing it to look that way.

Eventually, you’ll look back and say, “Selling the fronts would have been a good trade,” because in hindsight, the market calmed down. But that’s not a timeless lesson.

I think Benn is alluding to a great truth: there is no one thing that always works. Any strategy that consistently works gets discovered by sophisticated pattern seekers, and the very act of arbitraging that edge makes it disappear. So the things that work tend to be ephemeral, not evergreen.

Instead, it helps to think of prices as an adversary. What’s baked into this price? That’s a habit you develop over time.

For example, imagine the market hears that a tariff deadline gets pushed out 90 days. My reflex is: the market will likely bump that term vol higher. But maybe it’s overreacting— because if the volatility doesn’t settle down, the pressure to resolve the situation early increases, making the 90-day assumption less relevant. (Maybe selling that month as part of a calendar butterfly is better if you think the market is discounting other resolution periods too heavily).

So it becomes a habit. When you see a price that looks high or low, ask:

1. whether it’s justifiable (it usually is), and
2. whether you expect it to have overreacted or underreacted on balance.

I’m not surprised when optically high vols turn out to be cheap—people get anchored.

That’s why I try to look at everything relatively. I’m not just asking “Is this gamma going to underperform or outperform outright?”

The best time to trade an overreaction is when the overreactors are being forced—in other words, when the actions are non-economic. Knowing when that’s happening isn’t easy, but sometimes you can feel it—when markets go really wide, when there’s a ton of volume at insane prices, etc.