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Description and use

Short Combo is the opposite of Long Combo strategy. Short Combo is a synthetic strategy, because it simulates a share-selling situation. To establish the position, the trader buys lower strike Put options and sells higher strike Call options. This investment is short-term and is usually combined with other strategies. The direction of the market is bearish. The strategy is a net credit investment. The loss is unlimited when share prices are increasing.

  • Type: Bearish
  • Transaction type: Credit
  • Maximum profit: Limited
  • Maximum loss: Unlimited
  • Strategy: Volatility strategy

Opening the position

Short Combo Option Positions

Short Combo Option Positions

  • Buy lower strike (OTM) Put options.
  • Sell higher strike (OTM) Call options (same expiration as the Put options’).

Steps

Entry:

  • Make sure the trend is descending.

Exit:

  • The strategy should simulate the sale of an underlying security.
  • The portfolio should never contain a Long option in the last month before expiration.

Basic characteristics

Maximum loss: Unlimited.

Maximum profit: Lower strike price + Net Credit (or - Net debit).

Time decay: Time decay has a positive effect because of the Short Call, a negative effect because of the Long Put.

Breakeven point: Lower strike price (in case of net debit) - Net debit. Higher strike price (in case of net credit) + Net credit.

Advantages and disadvantages

Advantages:

  • The position is similar to a normal Short position when selling shares, but the cost is almost 0.
  • Unlimited profit in theory. In practice, the profit is limited because the share price cannot be lower than 0.

Disadvantages:

  • The potential loss is unlimited when share prices are increasing.
  • High Bid/Offer Spread has a negative influence on the position.

Closing the position

Closing the position:

  • Sell the Put options and buy back the Call options.

Mitigation of losses:

  • Sell the position when the share price crosses the Stop Loss limit.

Example

Short Combo strategy example

Short Combo strategy example

ABCD is traded for $35.10 on 02. 06. 2017.  The investor buys a Long Put option which has a strike price of $30.00, expires in August 2017. and costs $0.90 (premium). Then, he sells a Short Call option which has a strike price of $40.00, expires in August 2017. and costs $1.00 (premium).

Price of the underlying (share price): S= $35.10
Premium (Long Put): P= $0.90
Premium (Short Call): C= $1.00
Strike price (Long Put): KP= $30.00
Strike price (Short Call): KC= $40.00
Net credit: NCr
Maximum loss: R
Maximum profit: Pr
Breakeven point: BEP

Net credit: NCr = C - P
Maximum loss (risk): Unlimited
Maximum profit: Pr = KP + NCr
Breakeven point: BEP = KC + NCr

NCr = $0.10
R = unlimited
Pr = $30.10
BEP = $40.10