780 Part VI: Measuring and Trading Volatility 
A common mistake that calendar spreaders make is to think that such a spread 
looks overly attractive on a very volatile stock. Consider the same stock as above, still 
trading at 100, but for some reason implied volatility has skyrocketed to 80% (per­
haps a takeover rumor is present). 
Stock: JOO 
Implied Volatility: 80% 
Coll 
May 100 call 
June 100 call 
Theoretical Value 
12.55 
16.81 
On the surface, this seems like a very attractive spread. There are two months 
of life remaining in the May options (and three months in the Junes) and the spread 
is trading at 4.36. However, both options are completely composed of time value 
premium, and most certainly the June 100 call would be worth far more than 4.36 
when the May expires, if the stock is still near 100. The fact that many traders miss 
when they think of the calendar spread this way is that the June call will only be 
worth "far more than 4.36" if implied volatility holds up. If implied volatility for this 
stock is normally something on the order of 40%, say, then it is probably not reason­
able to expect that the 80% level will hold up. Just for comparison, note that if the 
stock is at 100 at May expiration - the maximum profit potential for such a calendar 
spread - the June 100 call, with implied volatility now at 40%, and with one month 
of life remaining, would be worth only 4. 77. Thus the spread would only have made 
a profit of a few cents (4.36 to 4.77), and if the underlying stock were farther from 
the strike price at expiration, there would probably be a loss rather than a profit. 
The point to be remembered is that a calendar spread is a "long volatility" play 
(and a reverse calendar spread is just the opposite). Evaluate the position's risk with 
an eye to what might happen to implied volatility, and not just to where the stock 
price might go or how much time decay there might be in the position. 
RATIO SPREADS AND BACKSPREADS 
The previous descriptions in this chapter describe fairly fully and accurately what 
the effect of volatility changes are. More complicated strategies are usually nothing 
more than combinations of the strategies presented earlier, so it is easy to discern 
the effect that changes in implied volatility would have; just combine the effects on 
the simpler strategies. For example, a ratio call write is really just the equivalent of 
a straddle sale - a strategy whose volatility ramifications are fairly simple to under­
stand. 
Ratio spreads, on the other hand, might not be as intuitive to interpret, but they 
are fairly simple nonetheless. A call ratio spread is really just the combination of some