Term Structure Arb

Calendar spreading is the primary vehicle for term structure trading, but they're not identical. Term structure trading is the strategy (profiting from changes in IV across expirations), while calendar spreads are the main structure used. You can also trade term structure via VIX futures, ratio calendars, and other structures.

Time decay (theta) accelerates as expiration approaches due to the non-linear nature of option value. An option loses roughly the square root of time remaining, so the last 30 days see more decay than the previous 30 days. The front month is always closer to this acceleration zone than the back month.

Yes, if the term structure moves against you. If front month IV rises (your short option becomes more expensive) or back month IV drops (your long option loses value), you can lose money even with the stock at your strike. Term structure risk is separate from directional risk.

At front month expiration, the short front month expires (hopefully worthless if stock is away from strike), and you're left with only the back month option. Typically, you'd close the entire position before front expiration to avoid assignment risk and to capture the time decay differential while both options exist.

No. Term structure trading works best when the curve moves in your predicted direction. Long calendars profit in normal conditions with stock near strike, but struggle when stock moves significantly or term structure flattens. Like all strategies, it has specific conditions where it excels and others where it struggles.

Single calendars are cheaper and have more profit potential at the strike, but a narrow profit zone. Double calendars cost more but have a wider profit zone (between the two strikes). Use single when you're confident about stock location; use double when you want term structure exposure with more room for stock movement.

If earnings fall between front and back expirations, the front month (pre-earnings) may have some elevated IV, but the back month (post-earnings) might not. Your calendar might experience unusual term structure - the relationship depends on whether earnings IV is already priced into the front month and how much 'normal' IV the back month carries.

VIX futures calendars are direct bets on the VIX curve shape - simpler to understand and execute. SPY option calendars involve more factors: stock price, two different expirations of IV, and Greeks. VIX futures have $1,000/point; SPY options have more nuanced exposures. VIX is for pure term structure; SPY combines term structure with other Greeks.

Roll when: thesis is still valid, front month expiration approaching, and you want to continue the trade. Close when: thesis has played out, thesis is wrong, or front month expiration risk isn't worth extending. Consider roll credit/debit - if rolling for a debit, make sure it's justified by remaining opportunity.

Size based on max loss (debit paid for long calendars). If debit is $2.50 and you risk 2% of $50,000 portfolio = $1,000 max risk = 4 calendars. Also consider notional exposure and gamma risk as front month approaches expiration. Don't oversize because calendars can have significant P&L swings.

Calculate forward variance using: Forward Var = (V2² × T2 - V1² × T1) / (T2 - T1), where V is volatility and T is time. This gives implied variance for the period between T1 and T2. Compare to historical forward variance to assess if it's rich or cheap. Trade by buying/selling calendar spanning that forward period.

Professionals decompose term structure into factors (level, slope, curvature) using PCA. They hedge level exposure with VIX futures or ATM options. Slope exposure is managed with calendar spreads. Curvature is harder to hedge - typically requires multiple calendar spreads at different points. The goal is targeting specific factor exposures while neutralizing others.

Calendar spread theoretical value relates to cost of carry (interest rates, dividends). The jelly roll structure (synthetic long in one month, synthetic short in another) prices to the carry cost difference. Discrepancies between actual calendar prices and carry-implied values can indicate trading opportunities, though execution costs often exceed the edge.

Market makers enforce the constraint that total variance must increase with time. If front-month IV implies higher variance than back-month, arbitrage exists (sell front, buy back). Market makers exploit these quickly, keeping term structure within no-arbitrage bounds. Residual opportunities exist in relative value (one asset vs another) rather than pure arbitrage.

High VVIX means the term structure itself is more volatile - your calendar P&L will have larger swings. Risk management: (1) Reduce position size when VVIX is elevated, (2) Widen stop-losses to avoid being shaken out, (3) Expect faster movement toward targets or stops. Low VVIX means more stable, grind-it-out trading with smaller P&L moves.