Calendar Spread Implied Volatility

In early winter 2012 dan successfully used a jan march long call calendar spread in nflx and a feb weekly march long put calendar spread in amzn going into their earnings.

Calendar spread implied volatility. Today s market measures takes an implied volatility iv spin on the idea of spread trading. More debit spread definition. In a pure diffusion setting you can equivalently write no calendar arbitrage constraints.

Vega is the greek that measures a position s exposure to changes in implied volatility. A calendar spread is a low risk directionally neutral options strategy that profits from the passage of time and or an increase in implied volatility. Practice problems and solutions.

The second way a calendar trade makes money is with an increase in volatility in the far month option or a decrease in the volatility in the short term option. Total implied variance should be non decreasing in time and that for any given forward moneyness level see gatheral top of page 4. Calendar spreads are long vega trades so generally speaking they benefit from rising volatility after the trade has been placed.

The trader will ordinarily implement this strategy when the options they are buying have a distinctly lower implied volatility than the options they are writing selling. Ideally if implied volatility was not as elevated in the later month as in the front month then the implied volatility will collapse much more in the front month than in the later month. The price based constraint builds on the following lemma.

Assuming initially that the spread consisted of options whose strike price was equal to the stock price when the spread was entered into implied volatility is the volatility that would explain the observed option price that is. In terms of implied volatility. See gatheral end of page 3.

In terms of european option prices. Calendar spreads and implied volatility. Our primary use of calendar spreads is to create a long theta long vega position while iv is low and options are cheap.