Last week, I talked about calendar spreads. Focusing on the potential that comes from a strategy that benefit from time decay. The assumption, of course, is that all other factors that make up an options price remain the same. Which by any definition is a stretch.

Factors change, as witnessed this week with the spike in volatility. In recognition of that, it is important to understand how changes in say, volatility, affect the strategy. Generally volatility has a greater impact on shorter term options. The reason is that volatility is not linear. A stock is just as likely to move sharply up or down on any given day or week, as it is to make that move over a month. Point is, a change in the value of the underlying stock can occur at any point. What this means is that a spike in volatility negatively impacts a calendar spread. It will cause the shorter term option to rise more dramatically than the longer term option.

In addition, significant moves in the underlying security will also negatively impact this spread. If ABX, which was the example I cited last week, were to rise above $43 or fall below $37, the spread will narrow, and cause a small loss. But in all cases – aside from early assignment - the risk is limited. Given that, there should be opportunities to the position with a profit some point prior to expiration of the short term option.

The ideal calendar spread is one where you use options on stocks with above average volatility –gold and oil stocks fit the criteria – and that will likely remain in a trading range between now and the expiry of the shorter term option.

Having selected stocks that meet that criteria, look at the implement the calendar spread using calls that are slightly out-of-the-money.