calendar spreads through the eyes of a vol trader
Friends,
I got long IBIT (BTC etf) when my April calls expired ITM. IBIT continued rallying, I was happy to stay long. However, the vol screened cheap.
I decided to “replace” — I sold my long shares and bought calls.
Deciding which calls to buy was tricky. So tricky it inspired this post.
The heart of the conundrum lives in this snapshot from 4/23/25:
That is the constant maturity IV term structure, visually depicting a steep term structure. The implied forwards table below it gives a more granular view.
You can see the problem.
I think vol is cheap…but that was confined to the front of the curve. If we just look at the first 2 monthly expirations, May 16th and June, the vols are 45.8% and 51.1%.
The premium from May to June is so steep that the May/June forward vol was 54.3%, a full 10 points over the weekly IV!
Vol might be cheap but you can only “lock” it in for about a month. Then it doesn’t look so cheap anymore. No easy trades, right? The market is pricing mean reversion in the vol.
I chose to go with what the market gave me — the cheap vol in the front. I sold my shares and bought the May 60 calls.
Well, the stock went up about 15% that month…but expired just below my long strike.
A 15% move in a month corresponds to a 52% vol move (.15 x √12) but I picked the wrong strike. Path is Anton Chigurh’s coin.
I chose the shorter expiry because that’s where vol was cheap. June was 5 vol points richer, more than 10% premium over a single month. Is that too much to pay? Does that nullify the “vol is cheap” thrust behind the trade idea?
There’s no straight answer to such a question.
The term structure balances a tension between the supply and demand in each month. Those flows are made up of both natural needs — directional speculation, hedging — and vol trader positoning insofar as they have opinions on the relative pricing.
The term structure is the jurors’ debate of the evidence. The truth behind the case, just like any trial is not perfectly known. In the market’s case, the ensuing price action, represents the truth.
Discerning between months and trading time spreads is a significant portion of vol trading. Understanding events is a mix of computation and research labor. There’s room for alpha in the act of normalizing term structures to account for idiosyncrasies in a calendar.
But let’s put that aside and assume a calendar with no known events.
We want to build some intuition of expensiveness or cheapness in a time spread. We can use a toy calculation to do this in the context of a common scenario:
“I am buying a time spread to harvest the front-month VRP”
If you sell the front month and buy the back, it’s a hedged way to capture the premium of implied to realized.
Note this premium, despite being empirical, is neither constant in magnitude nor size, but simply “on average”. Still, we can use this type of trade to explore the tradeoffs in month selection.
When we buy say, an ATM time spread, we are going to be long vega, long time premium, short gamma, and generally collecting theta.
Wait.
Why am I bolding “generally”?
It’s a clue to the tradeoffs involved.
Let’s just jump right into the toy model to see what we can learn about time spreads. This is stuff that excites, transfixes, and haunts every vol trader.
“What needs to be true for this time spread to be cheap or expensive?”
This will be the first in a few posts as I try to eventually turn this into a webapp.