Calendar Spreads and Implied Volatility: Practice Problems and Solutions

The Actuary's Free Study Guide for Exam 3F / Exam MFE - Section 45

This section of sample problems and solutions is a part of The Actuary's Free Study Guide for Exam 3F / Exam MFE, authored by Mr. Stolyarov.

This is Section 45 of the Study Guide. See Section 1 here. See Section 2 here. See Section 3 here. See Section 4 here. See Section 5 here. See Section 6 here. See Section 7 here. See Section 8 here. See Section 9 here. See Section 10

here. See Section 11 here. See Section 12 here. See Section 13 here. See Section 14 here. See Section 15 here. See Section 16 here. See Section 17 here. See Section 18 here. See Section 19 here. See Section 20 here. See Section 21 here. See Section 22 here. See Section 23 here. See Section 24 here. See Section 25 here. See Section 26 here. See Section 27 here. See Section 28 here. See Section 29 here. See Section 30 here. See Section 31 here. See Section 32 here. See Section 33 here. See Section 34 here. See Section 35 here. See Section 36 here. See Section 37 here. See Section 38 here. See Section 39 here. See Section 40 here. See Section 41 here. See Section 42 here. See Section 43 here. See Section 44 here.

A calendar spread involves selling a call option and buying a call option with the same strike price but a greater time to expiration. A purchased calendar spread takes advantage of time decay and the fact that the sold option will lose its value faster than the purchased option. Once the shorter-lived option expires, the buyer of the spread can make the most profit if the stock price remains unchanged. (Assuming, initially, that the spread consisted of options whose strike price was equal to the stock price when the spread was entered into.)

Implied volatility is "the volatility that would explain the observed option price." That is,