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Implied Volatility and Calendar Spreads

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

On the topic of spread trading, the conventional first thought is to trade a market like the S&P 500 against the Nasdaq, or some other variation of an equity, commodity, or currency market against another. Today’s Market Measures takes an Implied Volatility (IV) spin on the idea of spread trading.

Our primary use of Calendar Spreads is to create a long theta, long vega position while IV is low and options are cheap. Calendars, however, can also be used as a way of buying IV in a certain expiration while selling it in a different expiration on the same underlying market.

Our study attempts to buy 30-day IV and sell 60-day IV when the spread between VIX (30-day IV on the S&P 500) and VXV (90-day IV on the S&P 500) is widest. This can be done by selling the calendar spread in the S&P 500 (SPX).

The Results

The results of selling Calendar Spreads in SPX when the VIX-VXV spread was historically wide were less than optimal. After doing some further digging into the numbers, we found that this spread was widest when IV was low across all expirations. This is when we have seen long Calendar Spreads perform well, so we can see why this strategy did not work.

Catch the video above for further information regarding Calendar Spreads and Implied Volatility.

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