Calendar Spreads and IV

[Adamoptions]

I've recently started studying calendar spreads and I'm confused about something. Is it better to set up a calendar spread with options tending towards high implied volatility or low implied volatility? The way I see it, if you set up on a high IV, you collect more premium but you risk a drop in IV that could narrow your spread. If you set up on a low IV, you stand a better chance of your spread widening, but you collect less premium to begin with. How do you know which is best?

 

[maglia rosa]

That is exactly what a calendar spread is: a bet on forward volatility, the volatility between the two expiration months as implied by the spread. If you think forward vol goes higher, buy the calendar; if you think forward vol is going lower, sell the calendar.

 

[dlincke]

Ideally you want to find situations where there's a pronounced horizontal volatility skew (i.e. between the front and back months). Since the introduction of Reg FD such have tended to arise more frequently and be more pronounced ahead of earnings releases.