Volatility Skew Trades

Implied volatility (IV) is one of the most important pieces of options data used in finding a good calendar spread. The primary use of IV is to determine whether an option is comparatively overpriced or under-priced. Most options friendly brokerage firms provide IV data for options. The value of the IV for an option is calculated from a theoretical model for options pricing known as the Black-Scholes formula. Some discussion of the calculation of implied volatility is provided in Chapter 29, “Implied Volatility and the Black-Scholes Formula.”

If the current IV of an option is high compared to an annual average, it means that the price of the option is inflated with extra time value. In the case of calendar spreads, the ...

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