A few replies: When both strikes are ITM on exp day, there is no reason for your broker to close anything. You are already at max loss. All money invested is gone. If one strike is ITM on exp day, and you don't have the money to buy the stock, it is "YOUR" responsibility to close it. If you don't, your broker probably will. But what if there is some major event going on in the market and your broker is too busy to get to it? You could be assigned stock you don't have money to buy it with, even at max margin. In that case, you or your broker will sell at the open on monday morning, assuming they have not closed it during after hours on friday. Problem solved? NOPE! What if the market and your stocks open lower on monday morning, due to some negative event that occured over the weekend? Now you are in serious trouble. Because of the MASSIVE margin you were on over the weekend. If your stocks open lower on monday than both your strikes, you could actually be broke and still owe your broker some money. That will be a VERY STRESSFUL weekend for you, as you wait for the market to open. Don't assume your broker will close it for you on friday. It is YOUR responsibility. Don't assume they will save you from your own stupidity and reckless behavior. They probably will. But what if they are too busy to get to you? As for whether to select your strikes ATM or OTM,.... you select your strikes based on tech support, the stocks volatility, length of contract, ect.... Picking strikes based only on credit is not a smart thing to do... in my opinion. But that is an individual investor preference. The issue is not simply one of risk/reward. The issue is one of risk/reward/ and "probability". A trade with a strike at or above tech support, and more OTM, and not excessively volatile, has a higher "probability" of being successful, than one with excessive volatility swings, trading ATM, and not near tech support. (Risk/reward/probability.)
Yep, I deserved all that. My example was hypothetical, in reality I know where the responsibility lies. I know you have explained credit spread risk a few times, now that I have been perusing your thread, and I appreciate the time you have taken to point it out to me. I have been selling naked puts on stocks that I am fully prepared to own should I be assigned, and perhaps there is merit in keeping things simple. Cheers!
Personally I limit my spread use to stocks I do NOT want to own, stocks that are excessively volatile, and stocks where i have no idea where the bottom is. I'm not trying to discourage anyone from using spreads. Only to be aware of their potential risks. Too many investors think it's a cash secured trade, only to find themselves on massive margin, which they didn't even know they were on.
We need to stop throwing the term "margin" around. Anyway, there is potential to risk the entire debit. It's really not complex. You're long 20% of capital in a deep ITM vert at 400/500. Risking $400 to earn $100. If it goes tits-up you're out $400 on a $2,000 account. More important is to understand modality. The spread is long theta if ITM, short theta if OTM (generalizing w.r.t. moneyness here). Delta is unimodal which is good. When going with a fly you have modality risk to delta, g/t and vega (in order of mag).
<<< We need to stop throwing the term "margin" around. Anyway, there is potential to risk the entire debit. It's really not complex. You're long 20% of capital in a deep ITM vert at 400/500. Risking $400 to earn $100. If it goes tits-up you're out $400 on a $2,000 account. >>> I throw the term margin around, because the "threat" of it limits your choices, when trying to manage the risk of a deteriorating trade. If you can not even consider buying most of your trades in a spread type portfolio, all you can do is close your position for a loss. The time to think about, discuss, and consider the risks of "spread margin",... is BEFORE you need to think about, discuss and consider the risks of "spread margin". In your example above, you are refering to a specific trade. My discussion is about a spread strategy portfolio, composed of spreads. Big difference. If I had instead used similar cash for a narrow spread gap strategy on all my naked puts, and had to close all my trades that dropped a mere penny or more under it's strikes, because I could not even consider buying 95% of them,.... the value of my account would be at much greater risk than it currently is. And the reason for that greater risk, is the "spread margin", that many spread traders don't even realize they are on. That's why I think the term should be tossed around. Better to be aware of it's lurking presense BEFORE a trade is initiated, than after the stock begins to deteriorate. Going out. Read you later.
Actually it's meaningless. "Spread margin" is arbitrary and is not a functional leverage ratio. What do you think your delta-pos represents? Further, it has (SM) no convexity to vola, among others. Know you deltas or beta-weighted, coeffs, etc. Better still to limit your book to a theta figure, which has adequate convexity to (synthetic time) to keep you risk in line to what is essentially a VaR figure. If your thetas go negative on a short vola book then you should be hedged or getting flat risk. Watch your global deltas if you're running a neutral (theta and vol) book of options. You've got this library of congress of what is essentially noise. Sorry, but there is nothing to glean from an arbitrary "spread margin".
Until we have another week or two of what occured when the S+P downgraded our debt last year. And we even had plenty of warning it was coming. Imagine some other event occuring with no warning. While I can't prove it, I'm 100% sure there were plenty of credit spread traders who lost all or most of their account value during that period, as the market dropped 300 - 500 points almost daily. While you say there is not any real margin with spreads, it was that no real margin that killed them, as they had no choice but to close for a loss... either partial or total, because of that margin leverage hanging over them. I have the impression you and others think my discussion is merely about the occasional credit spread. It's not. It's about a portfolio composed of all or mostly credit spreads, in which the investors think they are engaging in cash secured trades, with protected and limited downside. And while that is true,... it is also false. All I'm doing is informing them of the falsehood aspect of the strategy, for those engaging in it, as a prefered portfolio strategy for their account. And I'm only doing it when new posters bring it up. My discussion is NOT about this or that individual spread. It's about the risks of an overall "so-called cash secured" spread strategy.
It's already been mentioned (as if it needs mentioning) that buying a 400/500 spread at 20% of your account.... is risking 20% of your account. A meaningless number in the sense that it relays no information about moneyness, vola, duration, etc. It serves no purpose to state the obvious as though you've invented the wheel. We got it. My 9yo gets it. Ostensibly we're adults and the fool that can't quantify the risk deserves what he gets. Risking 20% notional on a 20D LEAPS vertical on a utility stock is not the same as risking 20% on a 20D weekly NFLX vertical.
All I'm doing is informing investors about the hidden risk of suddenly becoming aware of potentially being on excessive margin leverage, via the use of credit spreads,... when many assume it's a safe, protected, "cash secured", limited risk trade. (((That sure does sound good on paper, when you read it like that.))) It's about that, and how suddenly finding that excessive leverage hanging over you, limits you "choices" for risk management during difficult times. I know everyone is sick of reading it. And frankly, I'm sick of typing it. But it's an important discussion for new readers who bring up the subject, who may not be as informed as you and your 9 year old. Although, I have a feeling your kid was well versed in options by the time he was 3. Can I assume he'll be putting out a book shortly? If so, i have a title suggestion for the book.