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?
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1 Answer
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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.
