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

CHAPTER 9

R&R and Time Travel for Shorty

Shorty left work at the end of the day and headed straight home. Eager to tell Sharon of the deal he had struck with Lon, he skipped his usual visit to the gym.

“You’re early,” said Sharon, greeting him at the door. “To what do I owe this great pleasure?”

“Well, something terrific happened today, and I couldn’t wait to tell you about it.”

“See,” he continued as they entered the kitchen, “I just made a great deal.” They took their normal seats facing each other around their small kitchen table. “As I’ve told you, I own 100 shares of Plum stock, which is currently trading at $40 per share—about the same I paid for it. But I think there’s a decent chance that this stock is going to go down in value in the near term—maybe even to $25 or $30. Well, I had my usual monthly lunch with Lon today, and guess what? He was willing to pay me $5 per share right now for the right to buy my 100 shares later for the current $40 price! In other words, he’s already paid me $5 and if he ever buys my shares he’ll pay me $40 more.”

I’ll just get to keep the $5 credit per share he’s already paid me. That’s a 12.5 percent profit.

Sharon’s brow was furrowed. “Okay, look at it this way,” Shorty continued. “I sold something to Lon; I entered a contract with him. For the price of $5 per share I sold him the right to buy my shares any time in the next six months for $40. We call that $40 our strike price. Now because he has the right to call out my shares, we call this ...