Many of your friends and family have been looking at calendars with the end of the year approaching but we are interested in calendar spreads and we have the study results that will guide you as to how and when (optimum IV level) to employ this strategy. Every option trader should know about calendars, especially new traders.
A calendar spread, also known as a horizontal spread or a time spread, combines different expirations into one position. The varying expirations play a role in theta decay, delta exposure and the trade’s cost.
A long calendar is a long volatility strategy. This is because the back month option has a higher vega than the front month. The short strike, with the closer expiration, has a theta component that decays more rapidly than the long strike in the back month which helps us collect premium.
A long call calendar with a strike slightly above the current underlying price benefits from an increase in IV or an increase in price. This strategy is relatively hedged because an increase in price typically causes a decrease in volatility. A table showing how price and volatility affect a calendar spread was displayed. The table included a volatility expansion in response to a price decrease and a volatility contraction in response to a price increase and the gains and loss from delta exposure and vega exposure.
A study using the SPY (S&P 500 ETF) from 2005 to present was conducted. We sold the front month closest to 45 days to expiration (DTE) and bought the back month closest to 75 DTE. We used the closest out-of-the-money (OTM) strike for both expirations and we closed out the trade the day before the front month expired.
A table of the results comparing calendar spreads when the VIX was greater than 15 and all occurrences was displayed. The table included the win ratio, average debit, average P/L and average return on capital (ROC). The results showed a significant difference between the two scenarios especially on the average P/L and the average ROC.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the valuable takeaways and other important information about Calendar spreads, especially when to trade them and when not to trade them.
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