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Strategy Discussion - Spreads: Debit or Credit

The Take-Away

Once again, it comes down to an issue of compromise. Enter into a bull or bear debit spread and early assignment is a favorable outcome and the exit strategy an easy one. Enter into a bull or bear credit spread and early assignment changes the risk-reward profile of the original position, could lead to additional capital being required and may force a closing of the position earlier than planned.

Are credit spreads worth the potential problems? The trade-off here is very easy to calculate. Our spreads on SockStock were established 53 days before option expiration. What is the value of a credit spread relative to a debit spread for this time period? Assume that the total value of the spread ($10) is invested at the risk-free rate (2.00%) and you obtain a value of $0.029. It’s your decision: close to three cents (with the credit spread), or the certainty that early assignment will not result in an unexpected outcome (with the debit spread).

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