Excellent analysis, which summarizes what many who have traded calendars in different volatility environments think about. Calendars are good in low vol environments and also very high vol environments. It is in the middle where they might struggle a bit. Study the vol curves of every calendar you consider.
Excellent video. I recently traded my first calendar at the beginning of this week and just couldn’t figure out why I was losing money as volatility increased even though my net Vega was positive. I searched online for a reason and couldn’t find any explanation for it. And here I found exactly the answer to that question just from stumbling on to your video because of the contrarian title. Thanks!
Chris, I like the way you broke down the components of options price. I never thought about breaking iv down with Vega. It's like breaking a vector into x & y components.
Chris, this video was a great not only because it was counter-intuitive, but also because you really broke down the reasoning for these calendar profits (i.e. directionality as opposed to volatility). I was blown away when seeing that volatility only accounted for $.10 of the profits in the example (~9-10 minutes in for anyone interested). Anyway, just know that there are people out here who understand that the quality of your videos is well above that of pretty much all other options channels.
Impressive and very high quality content. Thanks! Once you learn the basics of greeks, this is the type of video you should see to understand how they work real time, when to use which strategy. I use this calendar strategy for earnings. The current month/week IVs are always very high vs the back month, and when the right setup is available, it works perfect almost everytime.
Thanks for this analysis! I was extremely puzzled by the behavior of VXX calendar spreads when it spiked up in December. Was expecting the spread to increase in value but it decreased. This explains it so clearly.
Great video. This is one of the best breakdowns of the calendar spread I've seen so far. The one thing you didn't cover was how the calendar spread works when the near term option is close to expiration. It's in this time the theta decay of near term option is the largest and with the large deprecation in value that comes with being close to expiration an increase in vega will have a relatively larger effect on the value of the far term option.
Wait so hypothetically couldn’t you use a much smaller width to decrease you’re net Vega? For example sell the Feb16 call and buy the Feb19 call and you you’re net Vega would be much lower probably somewhere around like 0.1-0.01.
It is only true if we look the trade any time BEFORE the front-month option expires. If we wait until the expiration, the short option will trade in parity with stock and IV is not applicable for short option anymore. If meanwhile long option`s IV has increased then the trade has profited from volatility increase. Therefore it is a good way to trade volatility if the current IV level is low and we expect it to rise in the near future. I personally prefer calendar combinations instead of calendar spreads.
Thanks Chris! So, what would be the proper way to neutralize vega in case we have a number of vega-negative trades like iron condor and we want some protection against a possible volatility spike?
Well, given that a calendar spread can both make money or loose money depending on the relative changes in IV, how is the best way to screen for calendar candidates? Enter with low overall vol? how best to capture a change in vol?
need to track the vol surface = skew + term structure (pertaining to time spreads, cals & diags), but vol surface ultimately dictates which points on the surface are relatively cheap/rich vol-wise, structuring strikes & expiries accordingly
It means the ideal scenario for max profit in a calendar spread is when the near-term expiration cycle volatility decreases & long-term expiration cycle option volatility increases. Can this actually happen in real trade? In real trades, both will increase or decrease in tandem. am I right? You have tried to make the point that you can even sometimes earn when volatility falls. It can happen but that will only be a very short transitory phase and it also depends on when you want to close the trades. Usually, calendars are closed at the time of expiry of the short option. At that time the volatility will be only affecting the price of the bought option of the longer expiration cycle. At that time we need high volatility for our long option. So the point still stands that calendar spreads are long volatility trades in General. Please correct me if I am wrong.
Great explanation Chris..!! Love the way u explain the concepts makes it easier to understand.. If possible, would love if u make detailed video on Diagonal Calendar also.. Thanks in advance..
Great Video - How do we select strikes for calendar spreads based on Greeks and IV. I know for sure the IV for current month should be higher compared to the next month any particular calculations for other Greeks we need to look for while taking the trade as well as while exiting the trade?
Thanks for the comment! I personally don't trade many calendar spreads but when I do I typically select a strike that is near the stock price. I may choose a strike price a little further out-of-the-money but only if my assumption is that the stock will drift towards the strike price over time. Implied volatility in the near-term standard expiration cycle will actually typically be lower than the implied volatility observed in the back-month expiration cycle when you're trading equities. When buying calendar spreads, it's common to close the trade when the spread increases 50-100%. I did a large SPX calendar backtest a few months ago and I'd recommend you check it out: steadyoptions.com/articles/spx-calendar-spreads-historical-pl-levels-r270/ -Chris
With SPX being a European style option I can understand how the IV doesn't rise the same between the front and back month options. How much of an impact would it have to stick to doing Calendars on American style options instead?
Hi Richard, The same IV sensitivity relationship can be observed in equities with American-style options as well. Here are the IVs of the same options in SPY in August of 2015: August 20th: Sep 197 Put IV: 22.2% Oct 197 Put IV: 18.9% August 21st: Sep 197 Put IV: 24.6% Oct 197 Put IV: 21.1% So, a 2.4% increase in the Sep 197 put, and a 2.2% increase in the Oct 197 put. In this example, the difference was slightly less pronounced for these particular options. However, based on the midprice of each option, the calendar spread lost $0.04 through the move and increase in IV. When you look at the overall implied volatility of the September '15 and October '15 cycles on those days, we can see a substantially larger increase in the September cycle: August 20th, 2015: September '15 IV: 19.9% October '15 IV: 18.6% August 21st, 2015: September '15 IV: 29.3% October '15 IV: 25.3% Either way, large increases in IV usually occur with large movements in the underlying, which is of course a bad thing for long calendar spreads since you need the stock to stay near the strike price as time passes. I hope this helps! -Chris
Hi Chris, great analysis.could you please do similar video for diagonals. IV everytime affects my target exit for the diagonals. Does IV affect only double Diag or can affect directional diagonals as well?
Hi Chris, good stuff. I agree. But then I also wonder if reverse calendar / diagonal spreads (front side long and back side short) works in low ivol regimes?
I am not sure you can generalize your theory using VIX. VIX being "mean-reverting" keeps the further out contracts in check, and so the charts at 6:06 are specific to VIX contracts and do not apply to regular stocks.
VIX and VIX futures are directly related to options in varying expirations on the S&P 500 index (SPX). Without SPX options, there would be no VIX or VIX futures. If we look at the current implied volatility across varying expiration cycles, we can see longer-term expirations trading with higher IVs, and vice versa: imgur.com/vSzP0F0 In the event of a big market shock where heightened volatility occurs, the near-term options/expiration cycles will surge to higher IVs than the longer-term options/expiration cycles, which is what the chart at 6:06 demonstrates as well. In short: they are all connected which is why I felt using the VIX futures chart supported the idea.
Hi Ankit, I believe you may be watching the video in low quality. Sometimes, if your connection isn't strong, RUclips will play the video at a lower resolution/quality. You can change the quality of the video by following these instructions: support.google.com/youtube/answer/91449?hl=en Does this help?
Excellent analysis, which summarizes what many who have traded calendars in different volatility environments think about. Calendars are good in low vol environments and also very high vol environments. It is in the middle where they might struggle a bit. Study the vol curves of every calendar you consider.
Excellent video. I recently traded my first calendar at the beginning of this week and just couldn’t figure out why I was losing money as volatility increased even though my net Vega was positive. I searched online for a reason and couldn’t find any explanation for it. And here I found exactly the answer to that question just from stumbling on to your video because of the contrarian title. Thanks!
Chris, I like the way you broke down the components of options price. I never thought about breaking iv down with Vega.
It's like breaking a vector into x & y components.
Chris, this video was a great not only because it was counter-intuitive, but also because you really broke down the reasoning for these calendar profits (i.e. directionality as opposed to volatility). I was blown away when seeing that volatility only accounted for $.10 of the profits in the example (~9-10 minutes in for anyone interested).
Anyway, just know that there are people out here who understand that the quality of your videos is well above that of pretty much all other options channels.
I 2nd this
Impressive and very high quality content. Thanks! Once you learn the basics of greeks, this is the type of video you should see to understand how they work real time, when to use which strategy.
I use this calendar strategy for earnings. The current month/week IVs are always very high vs the back month, and when the right setup is available, it works perfect almost everytime.
Win %?
Thanks for this analysis! I was extremely puzzled by the behavior of VXX calendar spreads when it spiked up in December. Was expecting the spread to increase in value but it decreased. This explains it so clearly.
Great video. This is one of the best breakdowns of the calendar spread I've seen so far. The one thing you didn't cover was how the calendar spread works when the near term option is close to expiration. It's in this time the theta decay of near term option is the largest and with the large deprecation in value that comes with being close to expiration an increase in vega will have a relatively larger effect on the value of the far term option.
Exactly!
Wait so hypothetically couldn’t you use a much smaller width to decrease you’re net Vega? For example sell the Feb16 call and buy the Feb19 call and you you’re net Vega would be much lower probably somewhere around like 0.1-0.01.
It is only true if we look the trade any time BEFORE the front-month option expires. If we wait until the expiration, the short option will trade in parity with stock and IV is not applicable for short option anymore. If meanwhile long option`s IV has increased then the trade has profited from volatility increase. Therefore it is a good way to trade volatility if the current IV level is low and we expect it to rise in the near future. I personally prefer calendar combinations instead of calendar spreads.
Thanks Chris! So, what would be the proper way to neutralize vega in case we have a number of vega-negative trades like iron condor and we want some protection against a possible volatility spike?
Well, given that a calendar spread can both make money or loose money depending on the relative changes in IV, how is the best way to screen for calendar candidates? Enter with low overall vol? how best to capture a change in vol?
need to track the vol surface = skew + term structure (pertaining to time spreads, cals & diags), but vol surface ultimately dictates which points on the surface are relatively cheap/rich vol-wise, structuring strikes & expiries accordingly
So what's the play? Get calendars on stocks that have very high or very low IV?
It means the ideal scenario for max profit in a calendar spread is when the near-term expiration cycle volatility decreases & long-term expiration cycle option volatility increases. Can this actually happen in real trade? In real trades, both will increase or decrease in tandem. am I right?
You have tried to make the point that you can even sometimes earn when volatility falls. It can happen but that will only be a very short transitory phase and it also depends on when you want to close the trades. Usually, calendars are closed at the time of expiry of the short option. At that time the volatility will be only affecting the price of the bought option of the longer expiration cycle. At that time we need high volatility for our long option. So the point still stands that calendar spreads are long volatility trades in General.
Please correct me if I am wrong.
Great explanation Chris..!! Love the way u explain the concepts makes it easier to understand..
If possible, would love if u make detailed video on Diagonal Calendar also..
Thanks in advance..
Thank you! I should definitely do a video on diagonals. I need all the video topics I can get!
Thanks for the video. Are the situations you're describing here when a trader may want to reference Vanna and Charm?
Great Video - How do we select strikes for calendar spreads based on Greeks and IV. I know for sure the IV for current month should be higher compared to the next month any particular calculations for other Greeks we need to look for while taking the trade as well as while exiting the trade?
Thanks for the comment!
I personally don't trade many calendar spreads but when I do I typically select a strike that is near the stock price. I may choose a strike price a little further out-of-the-money but only if my assumption is that the stock will drift towards the strike price over time.
Implied volatility in the near-term standard expiration cycle will actually typically be lower than the implied volatility observed in the back-month expiration cycle when you're trading equities.
When buying calendar spreads, it's common to close the trade when the spread increases 50-100%. I did a large SPX calendar backtest a few months ago and I'd recommend you check it out:
steadyoptions.com/articles/spx-calendar-spreads-historical-pl-levels-r270/
-Chris
projectoption great read
the only thing is that initial and final vega values are different, vega P&L = vega * dIV, where vega is an avg between initial and final
Very logical explanation 👍🏻👍🏻
Thank you!
With SPX being a European style option I can understand how the IV doesn't rise the same between the front and back month options. How much of an impact would it have to stick to doing Calendars on American style options instead?
Hi Richard,
The same IV sensitivity relationship can be observed in equities with American-style options as well.
Here are the IVs of the same options in SPY in August of 2015:
August 20th:
Sep 197 Put IV: 22.2%
Oct 197 Put IV: 18.9%
August 21st:
Sep 197 Put IV: 24.6%
Oct 197 Put IV: 21.1%
So, a 2.4% increase in the Sep 197 put, and a 2.2% increase in the Oct 197 put. In this example, the difference was slightly less pronounced for these particular options. However, based on the midprice of each option, the calendar spread lost $0.04 through the move and increase in IV.
When you look at the overall implied volatility of the September '15 and October '15 cycles on those days, we can see a substantially larger increase in the September cycle:
August 20th, 2015:
September '15 IV: 19.9%
October '15 IV: 18.6%
August 21st, 2015:
September '15 IV: 29.3%
October '15 IV: 25.3%
Either way, large increases in IV usually occur with large movements in the underlying, which is of course a bad thing for long calendar spreads since you need the stock to stay near the strike price as time passes.
I hope this helps!
-Chris
Great video! Question: does this setup benefit from theta decline in the near term leg?
Thanks Project option...
Good effort in explaining detailed level...
Now I begin to understand the Greeks per your excellent vid. Utmost blessings!
Hi Chris, great analysis.could you please do similar video for diagonals. IV everytime affects my target exit for the diagonals. Does IV affect only double Diag or can affect directional diagonals as well?
This is just brilliant! Thank you for your explanations!
I am confused how the IV of each option is created or changes? Is it correlate with volume or something?
Good step wise analysis about the calender spread.
i never thought Vega changes, this video is so great to me
what i known is :
long calendar for lower V
short calendar for higher V
Hi Chris, good stuff. I agree. But then I also wonder if reverse calendar / diagonal spreads (front side long and back side short) works in low ivol regimes?
(delta * dSpot) + (0.5gamma * dSpot^2) + (theta * dTime) + (vega * dIV) = P&L greeks decomposition/attribution
What is the best way to quantify which option will be more sensitive to changes in IV? Would love to see a video on weighted Vega.
Check Ron Bertino's video named Weighted Vega
great video
Thank you!
excellent video, thank you!!
The Apr put has a higher IV than the Mar put. Is this common in real market?
Yes, when a binary event like earnings are expected in the back month.
I am not sure you can generalize your theory using VIX. VIX being "mean-reverting" keeps the further out contracts in check, and so the charts at 6:06 are specific to VIX contracts and do not apply to regular stocks.
VIX and VIX futures are directly related to options in varying expirations on the S&P 500 index (SPX). Without SPX options, there would be no VIX or VIX futures.
If we look at the current implied volatility across varying expiration cycles, we can see longer-term expirations trading with higher IVs, and vice versa: imgur.com/vSzP0F0
In the event of a big market shock where heightened volatility occurs, the near-term options/expiration cycles will surge to higher IVs than the longer-term options/expiration cycles, which is what the chart at 6:06 demonstrates as well.
In short: they are all connected which is why I felt using the VIX futures chart supported the idea.
projectoption Well explained
📈 💯
Does anyone else experience blurred text on the video slides?
Hi Ankit,
I believe you may be watching the video in low quality. Sometimes, if your connection isn't strong, RUclips will play the video at a lower resolution/quality.
You can change the quality of the video by following these instructions:
support.google.com/youtube/answer/91449?hl=en
Does this help?
1:36 "positive vega and positive VEGA" lol We know what you meant.