Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 4

Some Key Terms . . . that Almost Make Sense!

“This would probably be simpler if we used some other key terms, like we did with call. We’ve got a bunch of long sentences in there.”

“Okay, you’re right,” Lon agreed. “Let’s start with what I’m buying: ‘the right to buy if I want to.’ That phrase needs a word.”

“Easy. You’re paying for the option of buying at $40. Let’s just call it an option.”

“Well, I was thinking it’s kind of like a grocery coupon. . . .”

Shorty started to object, but Lon laughed. “Just kidding. We can use option. But can we use the word strike for the price? I mean the price we agreed that I can pay for your shares? I was just thinking that in baseball a strike is bad for the batter and good for the pitcher, just like—if the market price goes up—the $40 price is good for me but bad for you. And, of course, the reverse is true if the market price goes down.”

Shorty snorted. “I’m not sure I like sports analogies any more than grocery analogies. Lucky for you, there’s a better reason to use the word strike. After all, we struck a deal for $40, so we can call it a strike price if you want to.”

“So we have a call, an option . . . and look, since I have the option to call out your shares, can we combine them to create another term? Let’s just say it’s a call option. If I want to do this again, I can just say: Shorty, I want to buy a call option.”

“Absolutely. And let’s just call this whole thing a contract. An option contract. That’s obvious.”

“How about ...