Hello everyone, welcome back to the blog. What you see behind me is not the Burj Khalifa, but a chart of India VIX. The India VIX measures market volatility, indicating scenarios when market volatility increases, which can be favorable for buyers and a nightmare for sellers. Currently, we’re in an election period, a prime example of a high-volatility event. Understanding implied volatility (IV) can help you devise strategies with low risk and high returns. One such strategy is the calendar spread, which we’ll delve into today.

This blog is geared toward advanced traders, but even beginners will find value in understanding the basics of IV and how it relates to trading strategies. Calendar spreads are particularly useful for capturing IV and generating profits. We’ll explore what they are, how to deploy them, and the benefits they offer.

Calendar spreads are typically used in low-volatility scenarios and exited in high-volatility scenarios. These spreads involve buying and selling options with different expiration dates but the same strike price. The key is to deploy them during low volatility and exit when volatility spikes. This is especially relevant during specific events like elections or budget announcements, which are known to increase volatility.

Events like budget days often see increased volatility due to news and speculation. Leading up to the budget announcement, various news outlets speculate on potential changes in income tax and other economic policies. This anticipation drives up volatility, but once the budget is announced, volatility usually drops sharply. Often, the actual budget may not align with the speculations, leading to this drop in volatility.

Elections are another major event that can significantly impact market volatility. As elections approach, there’s widespread speculation about which party will win and their potential policies. For instance, as of today, the elections are ongoing and exit polls are starting. For the next two months, media coverage will fuel anticipation, increasing volatility. Once the results are out, volatility may either spike or drop, depending on the outcome and subsequent announcements.

Let’s consider a specific scenario: If a party wins and their manifesto includes significant economic reforms, the market may react with increased volatility. This reaction is often seen around the July 1 budget announcement following an election. The winning party typically outlines its plans for the next few years, which can include major infrastructure projects and economic policies, further driving market volatility.

Looking back, the budget announced on February 1 was an interim budget, which usually reiterates the achievements of the past few years rather than introducing new policies. Hence, there was not much market movement. However, the anticipation leading up to it had increased volatility, and traders who capitalized on this by using strategies like calendar spreads made significant profits when volatility dropped post-announcement. For example, traders deploying capital in normal strangles or straddles earned around 2.5% on their deployed capital due to the drop in IV.

Currently, with the elections in progress and results expected on June 5, we have a little over a month to observe and potentially capitalize on this volatility. Traders should consider calendar spreads during this period, as the ongoing political events will likely maintain elevated volatility levels, providing opportunities to profit when the market calms post-election.

Now, I will explain the concept of calendar spreads, a versatile options trading strategy. To fully understand calendar spreads, we’ll explore what calendars are, how to create them, and the different types of calendar spreads that can be employed. In a subsequent blog, we will discuss the strategic approach you should take for elections, deploying the same strategy together to provide a practical, relatable experience. Adjustments, if necessary, will be communicated through various mediums. Our primary focus will be on a straightforward and generally profitable strategy, provided the market conditions align positively.

A calendar spread, as the name suggests, revolves around different dates or expiries. Specifically, it involves options with the same strike price but different expiration dates. This is distinct from a vertical spread, where the expiries are the same but the strikes vary. In a vertical spread, such as a bull put spread or iron condor, all legs share the same expiration date, though the strikes differ. For example, an iron fly would have all its legs expiring on the same date but at different strikes.

In contrast, a calendar spread maintains the same strike price across different expirations. For instance, selling a put option with a 21,300 strike for the current expiry and buying a put option with the same strike for the next expiry. Both options are of the same type and strike, only differing in expiration dates. To better explain, let’s open the option chain of NSE (National Stock Exchange). By examining different expiries, we can illustrate how a basic calendar spread functions.

When dealing with options, especially selling, we know that the premium decays over time due to theta. The closer an option is to its expiration, the faster this decay happens. For example, comparing options expiring on May 2nd and May 9th, both with a strike price of 22,200, the one expiring on May 2nd will lose its value more quickly. In a calendar spread, we sell the option with the nearer expiration and buy the one with the farther expiration. This setup benefits from the faster decay of the nearer expiry while the longer expiry option retains more of its value.

Creating a basic calendar spread involves choosing an underlying asset with good liquidity. For this reason, Nifty is often preferred over Bank Nifty, as the latter sometimes faces liquidity issues that can make executing trades difficult. For instance, while trying to set up a perfect trade in Bank Nifty, you might find liquidity for only three legs but not the fourth, making it hard to deploy the trade effectively. With Nifty, such issues are minimal, though there may still be some bid-ask spread differences.

To illustrate, let’s take the Nifty option chain and set up a strategy using expiries of May 2nd and May 9th. If we choose a strike price of 22,200, we would sell the option expiring on May 2nd and buy the option expiring on May 9th. This setup is vega positive and theta positive, meaning it benefits from increases in volatility and the passage of time, respectively.

The primary advantage of a calendar spread lies in its structure. By selling the nearer expiry, you capitalize on the faster decay of its premium, while the longer expiry option, which you buy, decays more slowly. This slower decay helps mitigate losses and makes the strategy more resilient to market fluctuations. For example, in a bull put spread, the sold put option generates profit if the market moves in your favor, but the bought put option can incur a loss. In a calendar spread, the impact of theta decay on the bought option is less severe because it is further out in time, reducing the potential loss.

A calendar spread is a powerful options trading strategy that can be employed by conservative traders looking to minimize risks while aiming for reasonable profits. Let’s delve into the process of creating a calendar spread using the dates 2nd May and 9th May, focusing on the current market price of Rs. 2,150.

To start, the first step is to sell a put option for 2nd May at the strike price of Rs. 2,150. For simplicity, let’s assume you are selling 10 lots. This strategy involves the basic principle of selling an option with a nearer expiry date and buying an option with a further expiry date, both at the same strike price. Now, move to 9th May and buy a put option at the same strike price of Rs. 2,150. Essentially, you’ve sold one and bought one, creating a calendar spread with different expiry dates but identical strike prices.

Examining the graph after executing these trades, we observe several critical details. Firstly, the required margin for this trade is relatively low. For 10 slots, a margin of Rs. 2.5 lakhs is needed, implying that for a single slot, only Rs. 25,000 is required. The maximum profit potential of this trade is about Rs. 52,000, which equates to a 20% return on the margin employed.

However, potential losses also need to be considered. The downside loss on the put side is about Rs. 24,000. Despite this, the calendar spread strategy is known for its smooth Mark-to-Market (MTM) swings. Even if the market moves by 1.5% in either direction, the negative MTM impact is minimal, often only around Rs. 1,200 to Rs. 1,300 for 10 slots. This minimal loss is crucial for conservative traders who wish to avoid significant stress and poor decision-making under pressure.

If the market drops by 1.5%, the loss might show as Rs. 9,000, but this is before considering the impact of increased implied volatility (IV). When the market falls, IV typically rises, which supports the put side of the calendar spread, reducing the MTM loss to around Rs. 4,000. This inherent protection from IV spikes is a significant advantage of calendar spreads over strategies like strangles, where losses can amplify due to increased IV.

On the upside, the potential loss is around Rs. 17,000. However, this too can be managed by adjusting the hedges slightly. Understanding the Greeks is essential for refining and managing this strategy effectively. The key Greeks to focus on are Theta and Vega. A positive Theta indicates that the strategy benefits from the passage of time, generating approximately Rs. 1,700 daily if the market remains sideways. This positive Theta is due to the rapid decay of the sold option compared to the bought option.

Vega, representing the strategy’s sensitivity to volatility, is also positive. This means that the strategy benefits from an increase in volatility, which is crucial during periods of market uncertainty, such as upcoming elections. During such events, volatility tends to rise, providing an edge to the calendar spread, whereas traditional strategies like strangles, which are Vega negative, suffer losses from increased volatility.

The current state of India VIX, the volatility index, shows a small candle indicating a recent rise. Traders who sold calls and puts early in the morning might face losses due to this volatility increase, whereas those holding a calendar spread could see profits because the positive Vega balances out the losses from the sold leg with the profits from the bought leg.

A calendar spread strategy involves buying and selling options contracts with the same strike price but different expiration dates. Let’s take the example of a call calendar spread. Imagine the market is at 22,150, and to create a wider range, we choose 300 points away from the market both ways. We sell 10 lots of the 21,850 strike price call options for ₹100 each, which is about 300 points below the market. On the upside, we sell 10 lots of the 22,450 strike price call options for ₹97 each. Next, we buy similar strikes in the next month’s expiry, making both trades out-of-the-money. We buy 10 lots of the 21,850 and 22,450 strikes. This setup is a double calendar spread because it involves both call and put options.

The beauty of a double calendar spread lies in the extended range it offers. For example, this setup provides a coverage range from 21,690 to 22,600. If you anticipate the market to remain within 21,000 to 23,000, you adjust accordingly, like selling at 21,000 and 23,000 strikes. The aim is to utilize the maximum volatility around events, like an election result expected on June 5th. For maximum benefit, the buying leg should be around the May monthly expiry, a week before June 5th, around May 16th. Selling can be done a bit earlier, mid-May, to capture the volatility buildup.

When structuring this strategy, start by checking the market’s historical support and resistance levels. For instance, if 21,000 is a strong support and 23,000 a strong resistance, these become your anchor points. Selling 10 lots at 21,000 and 23,000 in the May 16th expiry and buying the same strikes in the May 30th expiry creates the calendar spread. Such a setup requires around ₹4.5 lakh in margin for 10 lots on both sides, covering a wide market movement range.

During high volatility periods, like elections, this spread can profit even with significant market moves, as implied volatility (IV) increases. For instance, a 6% market movement may still show a profit due to increased IV, even if the market doesn’t move much. A 20% IV increase is common during such times, enhancing your profit potential significantly.

When the IV is expected to rise modestly or remain stable, a diagonal calendar spread can be more efficient. This involves selling options at the same strike price but buying options at a slightly different strike, say 200 points away. For example, sell 21,000 in May 16th and buy 20,800 in May 30th expiry, and similarly, sell 23,000 in May 16th and buy 23,200 in May 30th. This reduces the debit outlay and brings the break-even range closer to the market.

A diagonal calendar spread still benefits from IV increases but is safer if IV remains stable. The cost of buying options at different strikes lowers the overall debit, making it profitable even without significant IV spikes. For instance, selling options for ₹50 and buying slightly out-of-the-money options for ₹75 reduces the debit and improves the break-even range.

The Greeks play a vital role in understanding these strategies. Theta measures the time decay, and Vega measures the sensitivity to volatility. A calendar spread with a high Vega and moderate Theta can be highly profitable during high-volatility events. For example, a calendar spread might have a Theta of 1,700 and a Vega of 4,892, showing how time decay and volatility impact the strategy. Reducing the debit through a diagonal spread might lower the Vega, making the strategy more stable but less dependent on high IV spikes.

Understand market volatility, especially when dealing with options. One key indicator of market volatility is the India VIX, which measures the expected volatility of the Nifty 50 index over the next 30 days. As traders, it is essential to know when to implement specific strategies based on the VIX levels. Today, we will discuss a particular strategy that works well when the implied volatility (IV) goes below 11 and how changes in volatility can impact your profits.
India’s VIX typically ranges between 9.2 and 30. When the VIX is around 9 or 10, it is an ideal time to consider a calendar spread strategy. This strategy is designed to take advantage of low volatility with the expectation that volatility will increase in the future. For instance, if the VIX is currently at 9 or 10, there is a high likelihood that it will rise to around 15, which can significantly impact your profit potential.

To illustrate, let’s examine a scenario where the VIX is at 10. If we anticipate that the VIX will increase to 15, our potential profit in the center of the range could be around ₹14,000. However, if the volatility remains unchanged, the profit might only be around ₹500. This substantial difference highlights the impact of volatility on our trading outcomes.

Now, let’s consider another scenario where we expect the VIX to rise to 30. Starting from a VIX level of below 10, a 30% increase in volatility can significantly enhance our profit potential. If the VIX rises to 30, our profit in the center can jump to ₹13,000 compared to just ₹500 if the volatility does not change. The main takeaway here is that an increase in volatility can greatly boost our profits, while a decrease in volatility can lead to smaller losses, making this strategy quite effective in low volatility conditions.

If the volatility decreases by 15%, the loss in the middle of the range might be around ₹2,000. This scenario underscores that even if the market remains range-bound, the losses are relatively small. The strategy is designed to minimize significant losses in a sideways market, where the VIX does not change dramatically.

When it comes to sudden market movements, an increase in volatility typically means that losses will be minimized, and profits will be maximized. For instance, a sudden movement causing a 5% gap up or down would likely increase the VIX, thereby reducing the potential losses. Reviewing the historical data of VIX can provide insights into when such significant gaps last occurred.

In practical terms, the range of profit can vary based on how much debit you pay initially. For a weekly or bi-weekly basis, you might see a range of around 5% to 6.5%. This is a substantial range for trading Nifty, providing a high probability of success. In fact, with an 87% probability, there is a high chance (9 out of 10 times) that this strategy will be correct.

If the IV increases to 30, the probability of profit rises to 90%, with a potential upper-side gain of 5.5%. This increased probability underscores the effectiveness of the strategy in volatile markets.

In summary, understanding and utilizing India VIX can greatly enhance your trading strategies, particularly in low-volatility conditions. By monitoring VIX levels and adjusting your strategies accordingly, you can optimize your profit potential while minimizing risks.

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