Calendar Options Strategy Video Series 3 of 7

In this calendar options strategy class we explain how the Calendar can behave as a negative Vega trade. This is very important to understand. Many option traders do not understand volatility well enough and believe this type of trade always makes money when vols rise and it always loses when IV drops. However, this is far from the truth. The calendar spread can be used to make money when IV drops just as effectively as when it rises.

Calendar Options Strategy Video Series 3 of 7

Video Transcript

Hi there everybody! This is Morris from San Jose Options. This is another really interesting discussion on the Calendar Spread. Although many people think of this as just a positive Vega trade, you can actually use the calendar as a negative Vega trade. The truth is it’s always going to have a mathematical positive Vega because of its structure. However, it will behave like it has negative Vega. Just want to clear that up. Let’s take a look.

How to use calendars after a debacle? This is what I call a debacle calendar. This can also be an earnings calendar, it kind of has the same type of effect here. It’s an earnings calendar or it could be a debacle calendar but let’s talk about the debacle situation first.

When we have a market debacle or your underlying hazard debacle itself, then what would typically happen is the volatility on your front month is going to move up faster and farther. That’s why I have this over here. You’re looking at the pretty sharp increase in volatility, short term. Notice again here, you have here front month volatility. The back month then is typically going to move up less and kind of at a slower pace and then farther out in time, even less. In farther out in time, let’s say this is really far out time like 3 years, a little bit less. It moves almost you could think of it like an earthquake in the epicenter. Over here you have your epicenter, your volatility move is going to be much more dramatic, faster, shorter term and it’s just going to hit you, boom. It’s just going to go way up and fast. And then, the farther you’re out in time, then, it’s going to move a little bit slower and move up a little bit less. It will drop kind of like that too.

Now, as the underlying symbol comes down, then what happens is is the front month does it again and repeats. Again, it drops down a lot faster and then your back month here, it drops down less. It moved up less and sometimes delayed I’ve noticed as well, and then it drops down a little bit slower and at times again delayed. If you study these, you may see that sometimes, that’s a day later, 2 days later, I’ve even seen up to like a 3-day reaction, which is kind of cool if you think about it ‘cause it gives you like a crystal ball.

Over here, you’re looking at again farther out in time. To summarize, they’re going to move up a lot faster, again talking about volatility, it’s going to go up a lot faster and then it’s going to come down a lot faster. So the way to take advantage of what I call a debacle calendar is when you have that debacle then it’s going to develop that skew. Your front month volatility goes way up, your back month may go up as well, it may not, it may be delayed by a day or two. The sooner you can get in there and capture that skew, you might get a better skew if you happen to enter the trade on that immediate, like the first or second day when that particular underlying has a fast move down.

Obviously, you have to think about long term problems if whatever the symbol is that you’re trading, if it’s looking at a long term problem that might be crashing for a month or so. That’s not what I’m talking about, I’m talking about these one-day moves or two-day quick moves maybe on some news or things like that. Now the way they work with earnings, again, it’s very similar. Before earnings come out, your front month volatility climbs up and it climbs up more than your back month. The same thing happens at positive skew develops. You can actually do a calendar that looks like this over earnings and then the front month will drop, the volatility will drop and then the trade can produce a profit. As long as it doesn’t move too much, up or down, directionally.
Really interesting, I always liked to talk about this but the calendar, while it’s known to be positive Vega and technically, mathematically it is positive Vega. So you can’t say it negative Vega, it’s a positive Vega trade. However, the behavior of it is a negative Vega in this type of situation.

Thank you very much! Remember, sjoptions.