What is a strategy?
June 16, 2010
What is a Strategy (continued)

When using options, you employ a strategy, which is simply a description of which options to buy and sell. 

Last time we talked about buying a call spread, in which you buy one call option and sell another.  When a trader buys a call spread,

  • The option bought has a lower strike price than you option sold
  • Both options have he same expiration date (discussion next time)
What is a 'strike price'?
When you own a call option, you own the right to buy 100 shares of stock at a specified price.
When you own a put option, you have the right to sell 100 shares of stock at a specified price
That 'specified price' is called the strike price
An example of 'buying a call spread is:
Buy 2 GOOG Sep 550 calls
Sell 2 GOOG Sep 570 calls

Note:  You buy the call option with the lower strike price.  The call option sold has the higher strike price.
The call option with the lower strike price always costs more than the call with the higher strike price.  Why?  The right to buy stock at a lower price is more valuable than he right to buy stock at a higher price.  [If this is not understood at this point, we will get to a discussion soon]

When you buy the more costly option, you pay cash for the spread.  Such trades are referred to as a 'debit spread' because you pay a debit to make the trade

When you collect cash for trading a spread, the trade is referred to as a 'credit spread.'.

Mark D Wolfinger

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