Credit Spreads

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 12, No. 2 on January 23, 2003. 

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 12, No. 7 on April 10, 2003. 

A subscriber recently asked the question, “If the market is breaking down and options are expensive, would a call credit spread be the best low risk spreading strategy to use?” It’s a good question, and the answer gets into a dichotomy of sorts – in that a credit spread might not be the best strategy even when options are expensive.

It is sort of a “knee-jerk” assumption that a credit spread will do better than a debit spread if volatility collapses. In reality, that’s not true. If they both employ the same strikes, they will perform the same (otherwise, risk-free arbitrage would be available).

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 16, No. 7 on April 12, 2007. 

This article reflects some new research (or, more appropriately, backtesting) that we have done regarding credit spread strategies. These strategies are very popular at the current time with a large number of web sites and advisory services. However, it seems that most people don’t really understand the risk that they’re taking in this strategy. Many stories are now surfacing about condor spread accounts with losses of 50%, 60% and more. Most of these were caused by being heavily invested in a month when the underlying made a maximum move.

For completeness, let’s start at the beginning. A credit spread involves buying one option and (simultaneously) selling another option – where the two options expire in the same month, but have different strikes. If the option that is sold is trading at a higher price than the option that is bought, a credit is taken in when the spread is established. Hence it is a credit spread.

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 4, No. 7 on April 13, 1995.

Credit spreads using options are a popular strategy. In this article, we'll define them, see how they work, and attempt to assess their true profitability. They have been growing in popularity recently, partially for the wrong reasons, as we will see later in the article.