I was reading about different option strategies at TradeKing and although I think I understand how these strategies work, I don't see how they are explained by the accompanied graphs.
So just to take two examples...
We have the basic "Short Put" strategy that has a graph like this:
This strategy obligates the seller of the option ("put") contract to buy the stock at strike price A if the option is exercised and assigned. The TradeKing page says:
This strategy has a low profit potential if the stock remains above strike A at expiration, but substantial potential risk if the stock goes down.
Then there is the "Short Put Spread" strategy that has a graph like this:
This strategy does two things:
- obligates the seller of the option contract to buy the stock at strike price B, if the option is exercised and assigned, and
- gives the seller of the option contract the right to sell stock at strike price A
The questions I have about these two graphs:
- What do the blue lines represent?
- It looks like the outcome from these strategies is more on the side of "loss" until the point where the blue line crosses the horizontal "Stock Price at Exp." line. Wouldn't it be more correct for the entire blue line be above the horizontal line (on the side of the profit) until point "A"?
(Admittedly I am probably misunderstanding something here)