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Tuesday, June 11th 2019

Backtesting Calendar Spreads Based on IV Contango

Backtest a calendar when the implied volatility term structure is in your desired shape. Set the Entry Indicator Trigger to Contango.

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Summary

Backtest a calendar spread based on IV contango by setting the entry indicator trigger to contango, which measures the slope of the 45 day implied volatility term structure. When contango is negative, the term structure is in backwardation, which is favorable for buying a calendar spread. By setting the max to 0 and leaving the min blank, you can run the long call calendar and compare it to a test not using contango. The SPY long call calendar had an annual return of 0.58% with contango set to max=0, compared to -0.09% without it.

You can instruct the ORATS backtester to trade a calendar only when the implied volatility term structure is in your desired shape.

The easiest way to do this is to use the Contango measurement. ORATS Contango is the slope of the 45 day implied volatility term structure. When Contango is negative, the term structure is in 'Backwardation'. Since when you buy a calendar you are buying the back month and selling the front month, you want the shape of the skew to be in your favor as much as possible, and this means you want Backwardation.

To trade only when your ticker is in Backwardation, you can set the Entry Indicator Trigger to Contango by clicking on the IV Rank drop down box and typing in contango. Set the Max = 0 and leave the Min blank as in the picture below.

 

Now you can run the long call calendar and compare to a test not using Contango.

I ran the SPY long call calendar with the default values and got an average annual return of -0.09%. With the Entry Indicator Triggers Contago set to Max=0, I got an annual return of 0.58%, a substantial uptick and was in the market 66% of the time.

 

Try it yourself. Get a free trial to the backtester HERE.

 

 

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The opinions and ideas presented herein are for informational and educational purposes only and should not be construed to represent trading or investment advice tailored to your investment objectives. You should not rely solely on any content herein and we strongly encourage you to discuss any trades or investments with your broker or investment adviser, prior to execution. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. Option trading and investing involves risk and is not suitable for all investors.

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The opinions and ideas presented herein are for informational and educational purposes only and should not be construed to represent trading or investment advice tailored to your investment objectives. You should not rely solely on any content herein and we strongly encourage you to discuss any trades or investments with your broker or investment adviser, prior to execution. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. Option trading and investing involves risk and is not suitable for all investors. For more information please see our disclaimer.
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