Term Structure Arb

More time means more uncertainty about where the stock will be. This uncertainty warrants higher IV for longer-dated options. It's the natural state when there's no near-term panic or event distorting the curve.

Yes, that's exactly how calendar spreads work. You compare front month IV to back month IV. The difference tells you about term structure. You don't need the full curve - just two points is enough for basic term structure trading.

You can lose the entire debit paid to enter the position. This happens if the underlying moves far from your strike or if IV collapses dramatically in the back month. Calendar spreads have defined maximum loss.

Front month options decay faster than back month options. Since you're short front and long back, the front loses value faster than the back. This net decay works in your favor - it's the primary profit driver in calm markets.

Earnings distort term structure predictably (the earnings month gets elevated IV). You can trade this, but be aware that the underlying often gaps significantly, creating gamma/delta risk. It's more complex than pure term structure arbitrage.

Calculate vega for each leg. Back month has more vega than front. To neutralize, sell more front month contracts than you buy back month. Example: Front vega = 0.08, Back vega = 0.12. Ratio = 0.12/0.08 = 1.5. Sell 3 front for every 2 back.

Roll if your term structure thesis is still valid but front month is approaching expiry (< 10 DTE). Close if the underlying has moved significantly, term structure has normalized (target hit), or your thesis has changed. Rolling maintains exposure; closing books the trade.

Calendars are short front month gamma (which is higher than back month). When the underlying moves, the short front month moves against you more than the long back month helps. Big moves create immediate losses that theta can't quickly recover.

Calendar captures RELATIVE IV changes (front vs back). IV crush captures ABSOLUTE IV collapse (like post-earnings). A calendar can profit even if absolute IV doesn't change much, as long as front IV falls relative to back. They're related but distinct exposures.

Separate into: 1) Theta P&L (time decay), 2) Vega P&L (parallel IV shift), 3) Term structure P&L (relative IV shift), 4) Gamma/Delta P&L (underlying movement). This requires tracking Greeks and IV changes at each expiration.

Forward variance = (V2²×T2 - V1²×T1) / (T2-T1). Convert IVs to variance (IV²), weight by time, and solve. This gives implied vol for the period between expirations. Useful for identifying if back month is expensive vs front.

Carry is net theta minus expected term structure drift. Roll yield is the cost/benefit of rolling positions forward. In contango, rolling long vol costs money (negative roll yield). In backwardation, rolling long vol earns money (positive roll yield). They're related concepts.

When vol spikes, term structure typically inverts. Calendars are net long vega, so they gain from vol spike. But inversion hurts the term structure bet (front IV rises more than back). These effects can offset, making calendars less profitable in vol spikes than you'd expect from vega alone.

Track both term structures daily. When they diverge (e.g., VIX inverted, XVI normal), assess if XVI will follow. Often XVI lags VIX by 1-2 days. Trade the convergence - position for XVI to follow VIX's term structure shape.

60-90 days is typical. Shorter (30 days) is too reactive to recent events. Longer (180+ days) includes regime changes that may not be relevant. Use rolling lookback and potentially regime-adjust based on vol level.