The students here at OptionsAnimal are given a thorough options education from beginning to end. As with all complex things that we learn, it is best to lay a strong foundation about the basic instruments of each trading strategy.
Then we build on that foundation, layering slightly more and more difficult concepts upon the firm foundation. I remember being new to options, not too long ago, and experiencing that “ah ha!” that comes with understanding the materials and how each piece fits into the bigger picture.
A new student asked me about one of the secondary adjustment choices to a basic one-option-directional-trade, the short put. While we say that it could be “closed at a theoretical break even” the better choice is to complete the upper levels and learn how to adjust it into a spread trade. However, when building the foundation of knowledge of the basic instruments, simple is better.
Does this adjustment work in the “real world?” No.
Mathematically, you’d think that if you sold a 50.00 put at a credit of $1.25, on XYZ trading at $50.00 that you’d reach a break-even point when the stock traded at $48.75. So, why doesn’t this work in real life? The answer is simple. The bid/ask spread.
If you sell that put for the $1.25 credit and one minute later think it was a mistake, what would you have to pay to close the put? Unless the price jumped up in that minute, you’d already be at a loss because we sell at the bid and buy at the ask. Some of our students remember it this way: The Bid is the wholesale price and the Ask is the retail price. The market maker is going to exact his/her price, and that’s why there is a spread between the Bid and the Ask.
Thankfully, we build upon the basic concept of selling puts by teaching spread trades. You’ll find the REAL solution to your secondary exit in the Options Animal level 5 classes. And, then, once these have been mastered you’ll see even more ways to combine the spreads in levels 7 and 8.