Calendar Spreads. Loose Ends

Part IV

This is Part V

Calendar spreads often represent an inexpensive way to take a bullish (buy OTM call calendar spread), bearish (buy OTM put calendar spread), or neutral position (but ATM calendar spread) on a specific stock or index.
Calendar

When you buy such a spread, you have a position that is long vega.  That means it does better (larger profit or reduced loss) when implied volatility increases during the time that you own the position, and loses money when implied volatility decreases.  Thus, when buying the calendar spread, it's important to recognize when the implied volatility is at a level you are willing to pay.  Currently, during the 2008 October massacre, implied volatility (as measured by VIX) is at a level that has never been seen before – except during the crash of October, 1987.  I won't be buying vega at this level, but that doesn't mean you shouldn't!

The bearish play offers the opportunity for higher profits than the bullish play – because IV tends to increase when the stock or index moves lower and tends to decease when the stock moves higher.

To me, the opportunity for calendar spreads occurs when IV is very low (not too long ago VIX was – what seems to be an unbelievable level – under 10, as recently as Jan 25, 2007).  For comparison purposes, VIX was as high as 76.94 during the day, last Friday (10/10/2008).  When that low VIX scenario occurs, it's very inexpensive to buy options, or make any play that includes positive vega – such as calendar spreads.

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