Which Layer of the Volatility Surface Should You Look at First?
Look at the at-the-money (ATM) layer first—more precisely, the "term structure" curve formed by ATM implied volatilities. This layer determines the baseline level of the entire surface and serves as the reference point for all subsequent analysis (skew, curvature).
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Step 1: Find the ATM implied volatility
What to do: On the options chain, locate the strike closest to the current price (the ATM strike) and read its implied volatility.
How to do it:
On the options chains of platforms such as Deribit, OKX, and Binance, find the column where Delta ≈ 0.5 or the strike closest to the current underlying price.
Read the IV values for that strike across different expiration months. These are the "ATM IV" for each tenor.
Professional tools such as Wenhua Finance allow you to bring up the volatility surface view directly on the options contract page, with strike on the X-axis, time to expiration on the Y-axis, and implied volatility on the Z-axis.
How you know it's done: You have ATM IV values for at least three expiration months (e.g., this week, this month, next quarter).
Step 2: Connect ATM IVs by time to form the "term structure" curve
What to do: Arrange ATM IVs from different expirations in chronological order and observe the slope direction of the curve.
How to do it:
Normal state (Contango): Back-month IV > Front-month IV. The term structure slopes upward, indicating the market expects volatility to gradually rise.
Inverted state (Backwardation): Front-month IV > Back-month IV. The term structure slopes downward, indicating the market prices short-term uncertainty higher than long-term.
Flat state: IVs across tenors are similar, indicating the market has no clear divergence in volatility expectations across time horizons.
How you know it's done: You clearly know whether the current term structure is upward-sloping, downward-sloping, or flat.
Key reminder: The term structure is the "foundation" of the volatility surface. If the foundation is inverted (near-month much higher than far-month), it means short-term panic dominates the entire surface; if the foundation is flat, the market is waiting for direction. Do not ignore the term structure before looking at skew.
Step 3: Use the absolute level of ATM IV as a benchmark
What to do: Compare the current ATM IV with historical averages to determine whether the overall surface is "expensive," "cheap," or "normal."
How to do it:
Use IV Rank or IV Percentile: the percentile of the current ATM IV within its historical range over a lookback period (e.g., 30 days, 60 days).
If ATM IV is at a historically high percentile (>80%), every layer of the surface is expensive; if at a low percentile, the entire surface is cheap.
Academic research also decomposes surface movements into three principal component factors: the level factor (overall IV level), the calendar factor (slope of the term structure), and the butterfly factor (curvature of the skew).
How you know it's done: You know the percentile of the current ATM IV and can judge whether "expensive/cheap" is global or local.
Step 4: Use the ATM baseline before looking at skew and smile
What to do: After confirming the term structure and overall level, then assess IV differences across strikes for the same expiration.
How to do it:
If you only care about the "general state of the surface," looking at the ATM term structure is enough. Volatility surface analysis typically has two main cross-sections: the term structure (expiration direction) and the skew curve (strike direction), with the ATM layer serving as the bridge between the two.
If you need fine-tuned trading (e.g., shorting volatility, trading skew reversion), then look at the IV difference between out-of-the-money puts and calls (skew).
The steeper the skew, the stronger the demand for downside protection; the flatter the skew, the more complacent the market.
How you know it's done: You have established the analysis sequence: "first term structure → then overall level → finally skew."
Prerequisites
Before starting, make sure the market data tool you use (Deribit, OKX, Binance options chains, or professional terminals such as Wenhua Finance) can display ATM implied volatilities for different expirations. If you only have an options chain without a visualization surface, manually recording ATM IVs for different expiration months can still accomplish the first two steps.
Common reasons for failure
The most common mistake is jumping straight to skew and ignoring the term structure as the "anchor." For example, front-month skew may be extremely steep, but ATM IV itself is also at a historical high—in this case the steep skew may just be a byproduct of short-term panic, not an independent signal. Another common problem is looking at the surface of only a single tenor and ignoring structural differences across tenors. The correct process is: term structure → overall level → skew.
Risk warning
Capital risk: Buying options (calls or puts) when ATM IV is at a historical high exposes you to IV decline that erodes option value. This is especially true for near-month options when the term structure is inverted.
Account risk: There are arbitrage relationships (calendar spreads) between different tenors on the volatility surface. If you trade while only watching one tenor, you may overlook cross-tenor risk transmission.
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Signs you have completed the process correctly
You can name the ATM IV values for at least three expiration months, you know whether the term structure is upward- or downward-sloping, and you know whether the current IV percentile is high or low. Next step: If you are going to open an options position, first use this "ATM layer + term structure + IV percentile" baseline to judge "is it a good deal to buy/sell now," then decide on a specific strike and strategy. If the term structure is inverted and ATM IV is at a historical high, selling strategies have a higher theoretical win rate, but be wary of further escalation of short-term risk.
