Figure 27 shows implied volatility for OTM Puts and OTM Calls, you will notice that Implied Volatility for Front Months can be higher than the Implied Volatility for Back Months, and that you can execute counter spreads to take advantage of that information. Also notice that the Time Decay for the Front Months is much higher than the Time Decay for the Back Months. This is what is referred to as Time Skew.

Figure 27- Implied Volatility Term Structure

Approach

• Often higher demand for Puts indicate that there is a higher difference in Volatility between the Front Months and the Back Months.

• Large horizontal Time Skew between two months can give you an advantage of the spikes in the Volatility of the market. If there is a binary event such as earnings, the Front Month contract that expires prior to the earnings will have spikes in the Implied Volatility and the Time Decay will be greater.

• The Theta decay in a Front Month is greater than that of a Back Month.

• Calendar Spreads are buying strategies that take advantage of the Time Decay, and benefit you when Implied Volatility is lower and options are relatively cheaper. The rate of Time Decay in the Front Months will be higher, and as long as the market does not make a rapid move to the Upside or the Downside and stays in the range, you can take advantage of the Time Skew and Time Decay.

• This provides an opportunity to buy options at a cheaper price and take advantage of Volatility potentially increasing thereafter.

• You benefit when Theta rises and you are already trading spreads, because the rise of the Theta means that there is a higher Time Decay in the extrinsic premium of options.