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

CHAPTER 35

The Two Basic Ways to Make Money in Spread Trading

“That’s true.And we will,”said Nate.“We just need to review one matter, and then we’ll get to them: four basic spread trades in addition to the collar.”

“And what we need to review,” said Aaron, “are the two basic strategies for making money with spread trades. We’ve already seen these two basic strategies with options in general, but now we need to be more explicit about them.”

“One strategy,” said Nate, “is basically to be in the selling position. In this kind of trade our main concern is to sell an option and receive a credit for it. That credit becomes our profit, and typically all we’re trying to do is protect it. In this kind of trade, we just want everything to expire worthless so that we can keep the credit without dealing with shares—without being forced either to buy or to sell them.”

One strategy is basically to be in the selling position. The other is basically to be in the buying position.

“That’s what I was always trying to do,” said Shorty.

“That’s right,” answered Aaron, “but now there’s a difference. In spread trading, we don’t only sell an option; we also buy one. That’s our combination: we do both. We take in a credit for the option we sell, and pay out a debit for the option we buy. And we manage the spread between these options in a way that will allow us to make money while reducing our risk.”

“And,” said Nate, “whenever this combination puts us in a net credit situation—whenever we’ve taken in ...