Explore Your Options by Tom Gentile
BUY LOW, SELL HIGH?
I’ve seen more than a few situations where longer-dated options trade at a significantly lower implied volatility relative to the shorter-term contracts. If a trader bought the cheaper contract and sold the more expensive one, like with a calendar spread, it seems to me as though there should be some type of profit opportunity. Could you please shed some light on this topic?
Great question. You’re correct in treating what seems like one of Wall Street’s proverbial free lunches with some care. The reality? If all that was required to turn a profit on a calendar spread was the simple lining up of “buying low” and “selling high” implied volatility (IV), there’d be no one to take the other side of the position. That’s not the case here, though.