Why Calendars Are Working Better, Despite higher IV

Sometimes, in all my analysis of implied volatility, my option mentoring students get a little lost as to what the net result of all of this volatility talk is:  price. In the end there is a real price to a trade.  As a pro trader, I have kind of learned to ignore the price, as I generally read the levels instead; however for the newer trader, I thought a view of implied volatility in terms of the price of a spread might really be of value.  

For instance, I do a lot of hemming and hawing about the IV spread between front month and back month options (term structure).  Today, I thought I could show you option traders why I currently like calendars by comparing the volatility AND the price of a 1 month calendar today vs. on 2 months ago on December 31st in the SPX.  This is a chart from LiveVolPro of 30 day IV for the last 3 months:


Two months ago the SPX was about 5% lower than it currently is, and the 30 day IV was almost exactly the same as it is currently.  In absolute price movement terms, that means volatility is up since then.  However, that doesn't mean calendars are a worse trade.  Take a look at the IV spread from December 31st (the Jan is the Yellow, the February is the Green):


Notice the width of the spread.  In this case Feb is trading far higher than Jan, and this creates a huge price gap between the months.  The closing price on the Feb 1260 calls was 28.00; the closing price on the Jan 1260 calls was about 16.20.  This produces a calendar that has 20 days to expire and a price of 11.80 a spread, not a cheap calendar.  If we look at today's IV spread (the yellow is March, the blue is April), what do you notice?


The spread is much tighter.  This produces a less expensive calendar, despite having only 17 days to expiration.  Today, the 1330’s marked at 15.30 and 26.50 respectively, a calendar that marks out (closed) at 11.20 a spread (although I have it worth closer to 11.00).  Paying .60-.80 less for a spread with less time to expire makes the calendar MUCH more favorable than the Jan-Feb spread, as in all things, it is always better to buy low.

So as you can see, while I talk about the IV and term structure a lot, in the end, the price is what matters! Do not forget to check out all the information on the new Option Pit Cruise!!  Also, register for all of our Webinars here.

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Graphs from LiveVolPro



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