Typically, volatility skews for calendar spreads between 10% and 25% work best.
Be suspicious of volatility skews between 30% or greater, particularly when both options have unusually high IVs.
An unusually high volatility skew often means that the front-month options are being used for wild speculation in the underlying stock due to some impending event that could dramatically alter the stock price.
If the IV skew is 50% or greater, the danger here for a calendar spread is twofold:
- It may instantaneously move the stock price out of the profitability range of the calendar spread.
- Even if the stock price remains unchanged, all the volatility will quickly collapse back to more normal levels after the event has passed. This is called a volatility crush.
A volatility crush can crush the price of the long option to a fraction of its original value, destroying the potential profit in the trade.
IV skew = (IV front-month – IV back-month) / IV back-month