Options Forum: Risk in Credit Spreads

The possibility of an early assignment is certainly a risk when writing credit spreads. But this is mostly at expiration if the short option is likely to expire in the money. By the Thursday or Friday of expiration week, you should have a pretty good handle on whether the short option on the spread will be assigned. Remember, for credit put spreads, this means the higher-priced strike, and for credit-call spreads, it's the lower-priced strike. Most brokerage firms follow the auto-exercise rule, which automatically exercises all options that are 25 cents in the money.

If it appears that the short, in-the-money options will be assigned, you always can take appropriate action in the underlying shares. For calls, this would mean buying enough shares to offset the assignment of those calls sold short. This will help you avoid carrying risk over the weekend. But I would wait until the last hour of the day before taking any preemptive action regarding assignment.

If the position was fully in the money, I would, as suggested above, look to close it out by entering a spread order with prices that represent fair value or the midpoint of the bid/ask. If the position goes unfilled, remember to exercise the options you own, which will offset the expected assignment of the short options.

Another important factor to consider when selling credit spreads, especially calls, is dividend dates. When a stock goes ex-dividend, it greatly increases the likelihood of an in-the-money call receiving an early assignment. Make sure you are aware of all ex-dividend dates on stocks in which you hold positions.

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