If you put on a credit spread, eg. buy a ABC July $570 call for $1.60, and sell a ABC July $560 call for $2.63, and both expire worthless, how do you calculate your return in percentage terms (what number goes into the denominator)?
Glad to hear from you again.
As you know your return on investment depends on the amount invested.
When trading credit spreads, there is no 'investment' per se. But, you have money at risk - and that amount is your investment.
Thus, the return = profit / money at risk.
In your example, return = $103 / $897
You sold a 10-point spread, and the maximum value that spread can achieve is 10 points, or $1,000. You collected $103 for the spread - making your maximum loss $897.
To provide a more accurate number, include commissions in the calculation. Thus the numerator is $103, less commissions. You can ignore the cost of closing the spread right now, but be aware of the commissions involved because you may want to exit the trade by paying a low price, and that $103 can disappear in trading costs if your commissions are too high.
Mark D. Wolfinger
The Rookie's Guide to Options:The Beginner's Handbook of Trading Equity Options