A common strategy for option volatility traders is spreading one or more option expiration against another. Items to consider when employing this strategy include theta (time decay), gamma, vega, relative volatility levels, skew, political announcements and pending economic reports.
Like most trades, there is a perceived ‘normal market behaviour’ pattern, or expectation in the mind of the trader initiating the position. For example, there is fact-based opinion that implied option volatility rises prior to scheduled economic report and declines as soon as the data is released to the market. In the majority of these cases, the options with the least amount of days to expiration (DTE) experience the greatest volatility increase prior to the data release and the greatest volatility decline after the data release. The reason for this behaviour is that the uncertainty of the information contained in the scheduled event/announcement disappears. The options with the shortest DTE are then subject to the greatest rate of time decay, which can make them an attractive item to be ‘short’, however, this assumption is dependent on prevailing volatility levels.
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