A Fat, Unintuitive Calendar Spread in SLV Explained

Episode Overview

• The podcast explains the concept of forward volatility, framing it as a practical indicator for market-making and guiding trading bias rather than a directly tradable instrument.
• A detailed case study on the silver ETF (SLV) is presented to illustrate how to identify a counterintuitive short calendar spread opportunity.
• The analysis uses tools like volatility cones to compare current implied volatility against historical realized volatility, revealing that long-dated SLV options were historically overpriced.
• The discussion concludes by challenging common options trading adages and highlighting behavioral traps traders should avoid.

Key Concepts

• Forward Volatility: Explained as an indicator for guiding trading bias, particularly in a "dirty market-making" context, rather than a directly tradable "pure" expression.
• SLV Case Study: A detailed analysis of an anomaly in the silver ETF (SLV) where long-dated implied volatility was priced higher than any realized volatility over the same duration in the last five years, making it appear "rich."
• Volatility Cone Analysis: A method of comparing the current implied volatility term structure against historical percentiles of realized volatility to identify pricing anomalies.
• Counterintuitive Calendar Spreads: The concept of selling a calendar spread even when the term structure is inverted, if it is not inverted enough relative to the high absolute level of volatility. The core thesis is that the back-month volatility has more room to fall.
• Trading Adages & Behavioral Biases: A critique of common options trading sayings (e.g., "Vega wounds, but gamma kills") and a warning against the behavioral trap of rationalizing a bad trade as a long-term investment.
• Greeks & Trading Practicalities: Discussion on the impracticality of maintaining Greek-neutral positions for theoretical trades and how option Greeks prevent traders from "lying" to themselves about a position's true risk.

Quotes

• At 1:44 - "Forward vol is an indicator, not a precise trade." - This is the central thesis of the initial discussion, distinguishing between theoretical metrics and actionable trading strategies.
• At 5:50 - "You can use the forward vol to better guide your biases, like... 'I'm a better buyer of March, and I'm a better seller of Dec.'" - This quote provides a concrete example of how a market maker would use forward vol to inform their trading decisions.
• At 20:42 - "Look where the implied vol is pricing. The implied vol in that six-month option is higher than any realized vol that we've experienced over six months in the last five years." - This is the core observation, highlighting that the market is pricing in an unprecedented level of sustained future volatility for silver.
• At 21:16 - "I'm thinking about this, I'm like, 'Yeah, you can lose to these front months, but they are going to go away and you're just going to be short this fat back month, which has a lot of room to fall.'" - He articulates the core thesis for a short calendar spread: the high-priced back-month volatility has a greater potential to decrease in value.
• At 24:04 - "What I'm saying is no, it's more relative than that... If the vol is high and the term structure is relatively flat compared to what I would expect... that tells me I actually want to be short that calendar." - He explains the nuanced, relative logic that makes the SLV trade attractive, even though it doesn't fit a simple rule.
• At 39:31 - "The vol trader's version of rationalizing a disappointing trade by turning it into an 'investment' and why the greeks don't let you lie." - He introduces a common behavioral trap where a trader changes their thesis to avoid admitting a mistake.
• At 42:32 - "You hear this expression, 'Vega wounds, but gamma kills.'... Hmmm, I'm not so sure about that amigo." - The speaker challenges a popular options trading adage, suggesting that large shifts in implied volatility (Vega risk) can be very damaging.

Takeaways

• Treat theoretical metrics like forward volatility as indicators to guide your trading bias, not as precise, standalone trade signals.
• Identify potentially overpriced options by comparing current long-dated implied volatility against historical realized volatility over a similar period.
• Evaluate term structure trades based on relative value, not just simple rules; a flat or inverted curve can be a shorting opportunity if absolute volatility is high enough.
• Challenge conventional trading wisdom and use the objective risk metrics of your position's Greeks to avoid the behavioral trap of rationalizing a losing trade.