We discussed the calculations of forward volatilities and flat forward volatilities in this prior post.
Today we will talk about a little know secret derived from the relationships of flat forward and forward volatilities calculations. And the bulls may not like what the signal is saying now.
Flat forwards are much less used than the normal forward volatility computation. Expert calendar spread traders use this calculation to exploit anomalies in the term structure. Flat forwards are more important to these traders because the calculation shows the IV level where both the front month and the back month match.
The ratio of flat forwards to regular forwards are important indicators in future stock movement. In our studies, extremes in the ratio of the flat forward and regular forward led to extremes in the underlying stock movement.
Let's look at two very different scenarios, the quiet 2017 and the volatile February 2018.
The quietest month of 2017 was October (ironically) with a historical volatility of 5.4%. Oct 2017 was also the high of the forward ratio.
The volatile February 2018 was preceded by a drop in the forward ratio. And so was the volatile October 2018 and December 2018.
What the signal now? Not good. And this may not bode well for the market.
Get access to the ORATS forward ratio today and get in on this options secret!
Sign up for the Data API free trial and request forward volatilities. We discussed the calculations of forward volatilities and flat forward volatilities in this prior post and signals from contango here.