Interpreting Expiration-to-Expiration Changes in Implied Volatility

Summary

The document explains how to interpret opposite moves in implied volatility for options expiring on adjacent dates. It emphasizes that implied total variance, rather than implied volatility alone, is the quantity to compare across expirations. Total variance is represented as time to expiration multiplied by implied volatility squared. Because expiration times differ, a higher or lower volatility quote by itself does not directly reveal the market’s change in expected variance over a particular interval.

The answer interprets the observed year-end pattern as a decline in expected realized volatility between the two expiration dates. It adds that the difference in total variance between the longer- and shorter-dated options must remain positive to avoid arbitrage. This is a concise conceptual explanation, not an empirical analysis of the options or a forecast. It does not examine other possible causes of changing quotes, such as liquidity, bid-ask effects, or event-specific repricing, and provides no data beyond the observation in the question.

Key ideas

• Compare implied total variance across expirations rather than comparing volatility quotes alone.
• Total variance equals implied volatility squared multiplied by time to expiration.
• Opposing changes in nearby expiries can indicate changing expected realized variance between their dates.
• The answer interprets the observed pattern as lower expected realized volatility over the intervening period.
• The explanation is conceptual and does not test alternative market or quote effects.

Tags

# week-over-week impacts on IV of of options with close to before/after EOY expirations


# week-over-week impacts on IV of of options with close to before/after EOY expirations












Tomorrow is the last trading day of 2023. Compared to last week, I noticed that $SPY ATM or close-to ATM options for the end of month/quarter (Dec-29) exp experienced a spike in IV since yesterday, however, the opposite effect (downward pressure) happened on the IV of same-strike options for the first week of Jan-2024. I cannot explain this change in vol space. Could somebody help me in the right direction?

## Answer by Yike Lu (score 1)

https://quant.stackexchange.com/a/77907

Implied total variance is the actual volatility quantity being bet on with options. IV is a convenient way to discuss total variance because the numbers are more intuitive. Let $\tau$ be the total variance, $\sigma$ be the implied volatility, and $T$ be time to expiration. Then

$$ \tau = T \sigma^2 $$

What you observed, in lay terms, was the expected realized volatility between the two expiration dates falling. As long as the difference in total variance between the long and short dated is greater than zero, there is no arbitrage.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.