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

CHAPTER 12

The Put: Reaching a Different Trade of Rights and Obligations

As they talked, Shorty and Lon discovered that they both held 100 shares of Nextall at $40 per share. Expecting that the stock price might fall to $25, Lon thought through a deal this way: What if I offer to buy the right to SELL Shorty my 100 shares of Nextall stock? I could pay him $5 per share right now, and have the option of selling him my 100 shares later at $40. If the stock price goes to $25, I have saved myself from a $15 loss because I can still sell my shares to Shorty at $40. And if I want to, I can actually buy more shares at this lower price with the money I take in from selling. This deal really pays off for me if the stock goes bearish. I’m also helped by having enough time for all this to happen, so I’ll offer a six-month expiration period again.

The only thing that’s different is that I won’t be calling out shares from you. I will actually be putting shares of mine to you.

And that’s what Lon offered. “Let’s enter a different kind of option contract, Shorty. I’ll pay you $5 per share right now to have the right to sell you 100 shares later at $40. Let’s say within six months. Now in this case, I’m not buying the right to buy 100 shares from you. I’m doing something different: I’m buying the right to make you buy 100 shares from me. I’m still shelling out money to make this deal and that means I’m still long, if we keep to our earlier terminology. The only thing that’s different is that I ...