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

CHAPTER 6

Strike Two . . .

“See, you offered me $5 per share to make our contract at the money. But what would you have offered me if you had wanted to make the deal at a strike price in the money—say, at $35 or $30?”

“Well, let’s look at the picture of our situation again, somewhat simplified.” (See Figure 6.1.)

“The lower the price I can buy shares for, the better it is for me,” continued Lon, thinking it through. “If the stock goes to $55 like I think it will, then I’m better off if I can get the shares for $35 than for $40. That’s $5 more in profits. So the lower the strike price—the deeper it is in the money—the better it is for me,” repeated Lon. “In fact, that’s exactly why we decided to call it in the money in the first place.”

“Right,” said Shorty. “The problem is, those in-the-money strike prices are not as good for me. Remember, since we set the strike price at $40, you will want to take my shares at the end of six months (if not before), if the stock price is something over $40. Of course, since you’ve already paid me $5, you actually need the stock price to go over $45 before you’re profitable (the $40 per share plus the $5 you’ve already paid). But, in any case, the idea is simply that you make money by the stock price moving higher than the strike price, and the more it’s over the strike price the more profit you make. Now I don’t think the stock price will get over $40, but it might. Still, I’m willing to take that chance because you’ve already paid me $5.

“But ...