• Long 1 put on a back date.
• Long 1 call on a back date.
• Short 1 put on a front date.
• Short 1 call on a front date.

<Calendar straddle swap risk graph retrieved from IB’s Trader Workstation.>

A long calendar straddle swap has a back-month straddle (further out expiration) and a front-month straddle (nearer expiration) on the same strike. A long calendar straddle swap (or a debit calendar straddle swap) is long a back-month straddle and short a front-month straddle. 

Advanced: Practical Application

A trader might want to hold long call calendar straddle swaps when expecting the market to stay in a contained range in the near term, such as when above Zero Gamma and in a positive market gamma regime. An ideal target for the strike price of a long call calendar straddle swap can be Absolute Gamma. On stocks, this compares to the Key Gamma Strike. 

The main idea of using a debit calendar straddle swap is to expect IV (implied volatility) to collapse on the front month. If IV is elevated on the shorter-duration short straddle in the front, then opening a strategy like this could lead to quick profits by closing the short straddle on the front if that event vol collapses, such as from earnings. The continued presence of the long back straddle keeps the risk defined. 

This strategy can also be applied with calendar strangle swaps, but this complicates the dynamic by creating a less profitable zone in the middle which gets worse if IV crushes. The main idea of using either approach is to expect IV to collapse in the front.

Expert: Term Structure Edge and Synthetics

There would be term structure edge if the date of the front straddle has a much higher IV than the long straddle on the back month, but only if after undergoing a forward IV calculation. 

The profit from that scenario would be captured by closing the short straddle in the front. From here, the decision is where to close the long straddle on the back as well, or to let it continue in expectation of a spike in realized volatility sometime over the next month. 

Like normal long calendar spreads, long calendar straddles swaps have nearly equivalent profit/loss dynamics and the same risk graphs as long butterflies, which set up a trade to bet on the price ending up in a specific and tight range. The strike selection of the straddle determines the location of that pin. This means that if you expect the price to end up right where it is [presently] that you would set up your straddles at the money. 

However, if you expect the price to drift down, then you could select straddles at a lower strike. And if you expect the price to drift up, then you can select straddles at a higher strike.  

back month: A back month in an option strategy is the one with higher amounts of days remaining to expiration. Without context, usually the front month means the immediate month (30 days to expiration) and the back month means the one behind it (31-60 days to expiration).

debit: In an option strategy, there is a debit paid from long options or debit spreads. This is the premium paid for the opportunity to hold the position. The debit also functions as the max loss of a long option position. The counterparty receives a credit as income until the option expires but takes on risks which can lead to losses and be significant if from an open-ended position. 

defined risk: In an option strategy, if risk is defined then it is structured so that it has a max loss (capped total loss on a trade) rather than potentially unlimited loss.

edge: An edge in trading is a competitive advantage but not one that guarantees a profit. It can be any method, idea, or tool which helps to outperform randomness. One way to interpret an edge is that it has a positive expectancy, which means that it would prevail as net profitable after many (ideally hundreds or more) occurrences. A single losing trade can be a good trade the majority of the time and a single winning trade can be just lucky without an edge.  The bottom line is that if you have edge in your trading then you have a positive expected value, where you should come out on top if your trading size is managed well enough that no single trade causes too much loss and allows for many attempts.

event vol: The extra amount of implied volatility that builds up on an option contract and inflates its price at major economic events such as earnings announcements. It is normal for this implied volatility (and the price boost which comes with it) to deflate after events. This is an extra steep premium which gets placed on options when there is the most specific demand for them, as these events can often lead to very severe moves. Event vol can be played on both sides: Either a trader goes long and considers the event vol to be at an acceptable premium—or short options are set up to harvest that extra premium as it deflates. However, without credit spreads (which limit the risk), those short options can take on extreme tail risk, undoing a year or more of small gains from these types of setups.

forward IV: Forward IV is the difference in IV that can be derived from two points on the term structure. It tells us how much IV needs to change from one date to the next after being adjusted for DTE (days to expiration). Forward IV is calculated as the square root of the difference in variance divided by the difference in time, with time (T) being the DTE. This can be expressed as: (T₂*σ²  - T₁*σ²)  /  ( T₂ - T₁). The DTE is multiplied against the IV% to weight it.

front month: When comparing option contracts that expire in different months, the front month has the shorter DTE (days to expiration).  

IV (implied volatility): The expected percentage range over a year with 68.3% confidence. This is based on options pricing at one standard deviation. Long options benefit from increases in implied volatility and short options benefit from decreases in implied volatility. In general, when implied volatility increases it means that the expected percentage range is getting larger. When implied volatility is applied to lengths of time other than one year, then this is called the expected move.

IV crush: A sharp drop in implied volatility which causes the price of an option to deflate. Short options benefit from IV crush and long options lose value from IV crush.

long call: To be long (buy and hold) an option contract which has limited risk and unlimited potential gains from moves up in the underlying price. The max loss is the cost of the call. Going long on a call is a simple way to gain upside exposure to movement in an underlying security, however the underlying security (such as a stock) must outperform the premium placed on that call by the options market. In other words, a long call must beat the options market in order to profit. If closed early (well before expiration) then a long call must outpace the expected move (priced in by the options market) for a specific period of time. All long calls have long gamma and long vega but short theta. It is uncommon to exercise calls rather than simply close them for a profit, however a long call is frequently understood as a right to exercise (trade in the long call to be long 100 shares) if above the specified strike price. Synthetically, a long call becomes logically equivalent to a long put if also short 100 shares.

long put: To be long (buy and hold) an option contract which has limited risk and amplified potential gains from moves down in the underlying price. The max loss is the cost of the put. Going long on a put is a simple way to profit from  downside exposure to movement in an underlying security, however the underlying security (such as a stock) must outperform the premium placed on that put by the options market. In other words, a long put must beat the options market in order to profit. If closed early (well before expiration) then a long put must outpace the expected move (priced in by the options market) for a specific period of time. All long puts have long gamma and long vega but short theta. It is uncommon to exercise puts rather than simply close them for a profit, however a long put is frequently understood as a right to exercise (trade in the long put to become short 100 shares) if below the specified strike price. Synthetically, a long put becomes logically equivalent to a long call if also long 100 shares.

RV (realized volatility): Shows the actual trading range of how much a stock is moving over a specific period. It is calculated based on historical movements, and measures the standard deviation, which means about how far it can be expected to move with a 68.3% chance. Another way to look at it is that 68.3% of historical moves would have fallen under what is measured as a standard deviation. Realized volatility can be applied to any length of time. It can also be used as a forecast of future [realized] volatility.

short call: To be short (sell to open and hold) a call. Unless otherwise hedged, the owner of the short call has unlimited risk and only limited potential gains, which makes this an extremely dangerous strategy in isolation. If left to expire, a short call will achieve max profit if the price ends up underneath the strike price. Shorting a call is a way to express a thesis that one is “not bullish” such as what might be justifiably the case if testing a Call Wall from underneath; being “not bullish” is different than being bearish. For a short call to be profitable, the underlying security must underperform the premium placed on that call by the options market. In other words, a short call profits when the underlying security fails to beat the options market. To be closed early for a profit, there needs to be a decrease in implied volatility or the underlying must have increased less than the options market has priced in for that specific period of time. All short calls have short gamma and short vega but long theta. Short options also come with obligations instead of rights, which means that, at any time, shares can be assigned (100 short shares for each contract); assignment usually only happens when in-the-money and near expiration). Synthetically, a short call becomes logically equivalent to a short put if the trader is also long 100 shares.

short put: To be short (sell to open and hold) a put. Unless otherwise hedged, the owner of the short put has severe risk and only limited potential gains, which makes this an extremely dangerous strategy in isolation. If left to expire, a short put will achieve max profit if the price ends up above the strike price. Shorting a put is a way to express a thesis that one is “not bearish” such as what might be justifiably the case if testing a Put Wall from above; being “not bearish” is different than being bullish. For a short put to be profitable, the underlying security must underperform the premium placed on that put by the options market. In other words, a short put profits when the underlying security fails to beat the options market. To be closed early for a profit, there needs to be a decrease in implied volatility or the underlying must have fallen less than the options market has priced in for that specific period of time. All short puts have short gamma and short vega but long theta. Short options also come with obligations instead of rights, which means that, at any time, shares can be assigned (100 short shares for each contract); assignment usually only happens when in-the-money and near expiration). Synthetically, a short put becomes logically equivalent to a short call if the trader is also short 100 shares.

straddle: A vertical option strategy which is long a call and long a put at the same strike (long straddle) or that is short a put and short a call at the same strike (short straddle). For retail traders, this is arguably the cleanest way to trade volatility (changes in the percentage range of a security) directly.

strangle: A vertical option strategy which is long an OTM (out of the money) put and long an OTM call at different strikes (long strangle) or that is short an OTM call and short an OTM put at different strikes. Like a straddle, a strangle is a way to trade volatility. Long strangles have less accuracy and less cost than long straddles; short strangles have more accuracy and more risk than short straddles.

term structure: A two dimensional graph of implied volatility (y-axis) compared to time (x-axis). IV (Implied volatility) is the expected percentage range over the next year—based on option prices—with 68.3% confidence. One important dynamic of term structure is that it is not simply enough to compare different IV% amounts side by side for term structure edge. Rather, different IV% amounts must first undergo a calculation for forward IV. After this calculation, if one IV% is higher than the other, then there can be a term structure edge in buying the lower IV% and selling the higher IV%.

Zero Gamma: Zero Gamma stands out as a SpotGamma level which is not support and resistance, but rather informative of the regime and climate of the market. Specifically, Zero Gamma sets the line of where negative or positive market gamma begins. Underneath Zero Gamma, market gamma is negative. Zero Gamma behaves like the eye of the storm, where feedback loops are not expected unless decently above or below it. Realized volatility (the expected percentage move over a period of time based on historical prices with 68.3% confidence) usually decreases when market gamma becomes significantly negative.