An option combination that entails the simultaneous sale of a call option and put option on the same underlying, but with different strike prices, different expiration dates, or both different strike prices and different expiration dates.
The short call option allows the trader to earn a profit when it expires at the money or out of the money, and the short put option allows the trader to earn a profit if it also would expire at the money or out of the money. However, if the market moves up or down, then the trader loses the amount by which the option is in the money. Since the trader is selling a call option and a put option, he receives option premiums from both contracts, and, thus, this position is a credit combination.
To determine the breakeven points of a short combination, the net payment received on the position need to be added to the short call’s strike price, and the net payment received on the position need to be subtracted from the short put’s strike price – anything above the upper (call option’s) breakeven point would be a loss, and anything below the lower (put option’s) breakeven point would be a loss. Any price within the range formed by these two levels would be a profit to the trader.
The maximum gain for a short combination is the initial premium income received by the trader from selling the options, while the maximum loss for it is unlimited. For example, an investor can establish a short combination by selling a call option on XYZ stock with June expiration and a strike price of $65 for a premium of $3 and selling a put option on the same stock and with the same expiration month and a different strike price ($55) for a premium of $2.5. This position can be summarized as follows:
- See 1 XYZ June 65 Call @ 3
- Sell 1 XYZ June 55 Put @ 2.5
- Market price of XYZ stock: $60
The trader has initiated a short combination since the “short” underlying security and the expiration months are the same, but the strike prices are different.
The long combination is similar to a short straddle.
For more on short combinations, see: short combination (tutorial).
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