Options Forum: Risk in Credit Spreads

I'm an avid reader of your excellent and commonsense columns. Would you consider a column commenting on: 1. Credit spreads; 2. the risks involved; 3. and the appropriateness of engaging in them for novice option investors such as myself. I'm really concerned about risk: What if I get assigned? Or, is the assumption being made that I will (can?) close out the credit spread before being assigned? What happens if I cannot close out both sides of the trade? Thanks in advance. -- R.C.

The first takeaway from this reader's email should be that flattery always helps. I was about to refer this reader to a recent column on credit spreads when I received a quick follow-up email saying he had already read the recent article but still had some questions regarding the mechanics and risk involved.

The real risk to credit spreads is always simply the difference between strike prices, minus the credit received. So, if you sell a $35/$40 call spread for a net credit of $2, the position's maximum profit is limited to $2, while the maximum loss is $3 per spread. One of the problems with credit spreads, compared to debit spreads or simply buying premium, is that even though they have a higher probability of being profitable (by profitable I mean earning even a single penny), the absolute risk/reward of the position is usually less than the even money. ...