LONG COMBO : SELL A PUT, BUY A CALL
A Long Combo is a Bullish strategy. If an
investor is expecting the price of a stock to move up he can do a Long Combo
strategy. It involves selling an OTM (lower strike) Put and buying an OTM
(higher strike) Call. This strategy simulates the action of buying a stock (or
a futures) but at a fraction of the stock price. It is an inexpensive trade,
similar in pay-off to Long Stock, except there is a gap between the strikes
(please see the payoff diagram). As the stock price rises the strategy starts
making profits. Let us try and understand Long Combo with an example.
When
to Use: Investor is
Bullish on
the stock.
Risk: Unlimited
(Lower Strike + net debit)
Reward: Unlimited
Breakeven :
Higher strike + net debit
Example:
A stock ABC
Ltd. is trading at Rs. 450. Mr. XYZ is bullish on the stock. But does not want
to invest Rs. 450. He does a Long Combo. He sells a Put option with a strike
price Rs. 400 at a premium of Rs. 1.00 and buys a Call Option with a strike
price of Rs. 500 at a premium of Rs. 2. The net cost of the strategy (net
debit) is Rs. 1.
Strategy
: Sell a Put + Buy a Call
|
ABC Ltd.
|
Current Market Price (Rs.)
|
450
|
|
|
|
|
|
Sells Put
|
Strike Price (Rs.)
|
400
|
|
|
|
|
|
Mr. XYZ receives
|
Premium (Rs.)
|
1.00
|
|
|
|
|
|
Buys Call
|
Strike Price (Rs.)
|
500
|
|
|
|
|
|
Mr. XYZ pays
|
Premium (Rs.)
|
2.00
|
|
|
|
|
|
|
Net Debit (Rs.)
|
1.00
|
|
|
|
|
|
|
Break Even Point (Rs.)
|
Rs. 501
|
|
|
(Higher
Strike + Net Debit)
|
|
|
|
|
|
The
payoff schedule
|
|
Net Payoff from
|
Net Payoff from the
|
|
|
ABC Ltd. closes at
|
the Put Sold
|
Call purchased
|
Net Payoff
|
|
(Rs.)
|
(Rs.)
|
(Rs.)
|
(Rs.)
|
|
700
|
1
|
198
|
199
|
|
650
|
1
|
148
|
149
|
|
600
|
1
|
98
|
99
|
|
550
|
1
|
48
|
49
|
|
501
|
1
|
-1
|
0
|
|
500
|
1
|
-2
|
-1
|
|
450
|
1
|
-2
|
-1
|
|
400
|
1
|
-2
|
-1
|
|
350
|
-49
|
-2
|
-51
|
|
300
|
-99
|
-2
|
-101
|
|
250
|
-149
|
-2
|
-151
|
For a small investment of Re. 1 (net debit), the
returns can be very high in a Long Combo, but only if the stock moves up.
Otherwise the potential losses can also be high.
The
payoff chart (Long Combo)
+ =
Sell Put Buy Call Long Combo
