Implied Volatility Entering The Options Chain can be a complex trading concept to understand. P&L change in a calendar spread is determined by how implied volatility enters and exits the options chain. In less than 3 minutes we simplify the concept and provide a best case scenario!
Click here or in the video below to discover the optimal situation!
00:56 S&P 500
01:49 Rate of change
How does implied volatility enter the market?
When uncertainty enters the market, whether it’s a bank failure or an FOMC event that’s planned that presents uncertainty in the market.
And it’s not necessarily a price drop or a price increase. In other words the market moves it could be news related or an impending event.
And so how does it manifest itself in the options market? Is it going to show up in higher demand in the 60-day series or in the 30-day series or in the front month or In the front cycle? You know how think about it that way. Where is it happening?
Think implied volatility like a wave…
then implied volatility is, if you’re thinking about it correctly, obviously going to come in the closest cycle to expiration. So we have weeklies right, I think in the SPX they are darn near every single day. So that series is going to be impacted from the uncertainty up until when that if it’s a news event, the FOMC or earnings. You’ll see that in stocks. You’re going to see the implied volatility is going to come into or impact the cycles or option expirations in the front first and then at a decreasing rate they’re going to impact expiration series further out.
Understanding how far that wave, if you will, comes into those expiration series and how much it impacts them, is critical to understanding calendars. And then the reverse is is when that uncertainty passes, how is that wave going back out to sea so to speak, how is that rate of change impacting the front cycle and back cycle?
The suitcase analogy
Does that analogy make sense John? Yes, yes it absolutely makes sense. And when we did implied volatility for Ultimate Income Trader I had a suitcase I was throwing at people in the crowd. I picked it up and said, “Who’s most concerned about getting hit by this suitcase?” And the people in the front row are like, “We Are!” The back row says we’re not concerned at all because you can’t throw that far. We don’t believe it. So same thing.
Real simply put. If you could take advantage of uncertainty coming into the short that you’re going to sell which is the front cycle of the calendar and then that implied volatility doesn’t impact your back long that much, that would be what we would consider an optimal situation. So if you can think about how implied volatility or uncertainty enters the options chains like a wave going in and out in the ocean, I think it really helps to set the visual of what’s happening.