Calendar Spread: Playing Volatility
Even though the Calendar Spread may be used in numerous stock market environments, they operate the best in low volatility climates. While soaring volatility levels are wonderful for these trades, sinking volatility levels bring them a lot of pain.
Mainly because calendar spreads churn out profit the fastest at neutral to rising volatility levels, some calendar spread traders will wait to make a trade right up until an underlyings volatility either reach the lowest level of their average range, or until they move into the lower third area of their normal volatility range.
By waiting for these lower ranges, the calendar spread trader is increasing his or her odds that the volatility levels will either remain wherever they’re and not go much lower which could wind up hurting the trade, or will start to rise back up which could put their calendar trade into significant earnings pretty swiftly.
Normally volatility levels sink as the market moves upward and rise as the market moves down. This is why many option traders will place calendar spreads when they have a bearish view on the market.
A well-liked technique for income calendar spread traders with a bearish outlook would be to place a calendar spread slightly below where the stock is presently trading at, with the hope that as the stock does start to head down as they anticipated, it will move directly into the center of their calendar position as the volatility soars – quickly pumping a significant gains into their calendar trade.
When using this method with the double calendar spread – it’s possible for the trader to increase their odds even more, as they can set up their calendar spread with a skew that not only creates a sweet spot in the area where the trader believes the underlying will be heading, but also provide profit coverage in a wider area that includes the area where the underlying is currently trading at just in case their belief about market direction turns out to be wrong.
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