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

CHAPTER 23

Best of All: Did You Know You Can Combine Option Instruments?

“What’s that?” challenged Lon. “I think we’re doing pretty well. What are we doing wrong?” “Well, you’re both far too limited,” answered Nate, “and that means you’re both taking far too much risk. Lon, you like doing long trades, or debit trades. You like shelling out money to buy rights. For bullish trends you place long calls, and for bearish trends you place long puts.”

“And Shorty,” said Aaron, “you like doing short trades, or credit trades. You like taking in money and then waiting out the expiration period. For stagnant/bearish trends you create short calls, and for bullish trends you create short puts.”

You’re both far too limited and that means you’re taking far too much risk.

“Unfortunately, this isn’t very flexible. In addition, it requires you to be good at calling trends . . . and how good are you at that? There are valuable technical signals you can use to help, and we will cover them tomorrow night, but even they can’t account for the effects of earnings reports, economic data, and pronouncements by the Fed. Any one of those factors can rapidly turn a trend in the opposite direction from the one you are expecting. Then how good is your option strategy?”

“Right,” added Aaron. “Suppose you have a long call on Plum because you expect a bullish trend, and then an earnings report scares the market and the stock turns bearish. What happens to your long call then?”

“Well, it goes down in value,” answered ...