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

CHAPTER 5

Strike One . . .

“That’s right,” agreed Lon. “Let’s think about it for a minute. Let’s say I had offered to make a deal at, say, $30 or $35. Since the stock was trading at $40, those strike prices would have been worth money immediately: I would have been buying the right to buy stock at prices already lower than the market price. Think about it. If I bought at those prices, and then turned around and sold on the market, I would be profitable automatically.”

“Yeah, those strike prices already have monetary value for you; they’re ‘in the money’ right from the start.”

“So let’s do this,” urged Lon. “Since Plum stock is currently trading at $40, let’s create a list of possible strike prices around that number and see how we would think about them.” He wrote the following dollar amounts on a page:

 

Strike Price

$25

30

35

40

45

50

55

 

“Of course, I could have put these numbers in the opposite order,” Lon observed, “starting with the high numbers and going down. But, actually, it makes sense to me to have the first number we read be the low number. Then as we read the other numbers they get progressively higher. Make sense?”

“Actually, I would have done it the other way,” responded Shorty. “Still, if I think of this list in terms of the first number being the lowest, I can make sense of it. I’ll try to remember that that’s how it works.”

It couldn’t be any simpler: buy low and sell high.

“But notice something else,” said Shorty. “Every strike price under $40 is good for you ...