How can I close a spread?

How can I close a spread?
by Bryan Perry 05/06/08

Q: If I close a debit spread as a whole at one time, the gain is almost nil. In fact the difference between bid and ask tends to eat into whatever little margin one has on a spread position. Do you recommend closing a spread this way?

A: You can close a spread a variety of ways:

1. Closing both legs (or, sides) of the spread trade in one transaction
2. Closing just one leg (or, "legging out")
3. Letting it expire

Particularly with a trade that isn't going your way, parting with the commission costs to unwind the position can be difficult, especially if you've held on to it longer than you probably should have "just in case" it could rally up (or back) to a point where you can break even on the investment.

But the benefit to letting a debit spread expire is that, even in the worst-case scenario, the options have some value on expiration Friday because the long option cancels out the short one, so you're not at risk to buy or sell the stock.

There are times when it would make sense to close the long option if it has some value, as you've already collected the credit on the short option and, if the stock really isn't moving much, it might be a long shot for you to get assigned the short option if the stock price is trading near the options' strike prices.

(The short call becomes valuable to a call buyer if the stock price rises, and the short put is generally only worthwhile to the put buyer if the stock trades below the strike price.)

Although we'd caution you against letting a single-option trade expire (without suggesting that you decide with your broker whether or not you wish the option to be exercised), letting the spread expire on its own would entitle you to any remaining value (if there is any) without the commission costs.

Remember, though, expiring spreads that show the long leg of the spread in-the-money by less than 5 cents and the short leg of the spread in-the-money more than 5 cents may require special attention to manage the expiration risks. Your broker can offer more-specific guidance on the best course of action.