Because volatility has peaks and troughs, this can be a smart time to sell a
calendar. The focus here is in seeing the “cheap” front month rise back up
to normal levels, not so much in seeing the “expensive” back month fall.
This trade is certainly not without risk. If the market doesn’t move, the
negative theta of the short calendar leads to a slow, painful death for
calendar sellers.
Another scenario in which the back-month volatility can trade higher than
the front is when the market expects higher movement after the expiration
of the short-term option but before the expiration of the long-term option.
Situations such as the expectation of the resolution of a lawsuit, a product
announcement, or some other one-time event down the road are
opportunities for the market to expect such movement. This strategy
focuses on the back-month vol coming back down to normal levels, not on
the front-month vol rising. This can be a more speculative situation for a
volatility trade, and more can go wrong.
The biggest volatility risk in selling a time spread is that what goes up can
continue to go up. The volatility disparity here is created by hedgers and
speculators favoring long-term options, hence pushing up the volatility, in
anticipation of a big future stock move. As the likely date of the anticipated
event draws near, more buyers can be attracted to the market, driving up IV
even further. Realized volatility can remain low as investors and traders lie
in wait. This scenario is doubly dangerous when volatility rises and the
stock doesn’t move. A trader can lose on negative theta and lose on negative
vega.