The Long Combo is an options trading strategy that allows investors to profit from significant price movements in the underlying asset. It involves both buying call options and selling put options simultaneously. This strategy is considered a bullish strategy, meaning the investor expects the price of the underlying asset to increase. Let’s break down the Long Combo strategy in simple terms:
How the Long Combo Works:
Step 1: Buy Call Options
- The first step in the Long Combo strategy is to buy call options. A call option gives you the right, but not the obligation, to buy the underlying asset at a specific price (known as the strike price) on or before a specified date (known as the expiration date).
- By buying call options, you’re betting that the price of the underlying asset will rise before the option’s expiration.
Step 2: Sell Put Options
- The second step is to sell put options. A put option gives the buyer the right, but not the obligation, to sell the underlying asset at the strike price on or before the expiration date.
- By selling put options, you’re taking on the obligation to potentially buy the underlying asset at the strike price if the option buyer decides to exercise the option.
When to Use the Long Combo:
- The Long Combo strategy is employed when you have a bullish outlook on a particular asset. You believe that the asset’s price will rise, and you want to take advantage of potential gains.
- This strategy can be particularly effective when you expect a significant price movement, but you’re not sure about the direction (up or down) of the movement.
Example of the Long Combo Strategy:
Let’s say you’re an investor who believes that the stock of Company XYZ, currently trading at $50, will experience a significant price movement soon. However, you’re unsure whether it will go up or down. You decide to use the Long Combo strategy:
Step 1: Buy Call Options
- You buy one call option of Company XYZ with a strike price of $50 and an expiration date one month from now. This option gives you the right to buy Company XYZ’s stock at $50 per share within the next month.
- Step 2: Sell Put Options
- You sell one put option of Company XYZ with a strike price of $50 and the same expiration date. By selling this put option, you’re taking on the obligation to potentially buy Company XYZ’s stock at $50 per share if the option buyer decides to sell it to you.
Outcome Scenarios:
- If the Price Goes Up:
- If the stock price of Company XYZ rises above $50 before the expiration date, your call option will be “in-the-money,” and you can exercise it to buy the stock at $50 per share. You can then sell the stock at the higher market price, making a profit.
- Your sold put option will expire worthless since the option buyer has no reason to sell the stock to you at $50 when the market price is higher.
- If the Price Goes Down:
- If the stock price of Company XYZ falls below $50 before the expiration date, your call option will expire worthless, as there’s no benefit in exercising it to buy at $50 when the market price is lower.
- Your sold put option may be exercised by the option buyer, requiring you to buy the stock at $50 per share. However, this risk is offset by the profit you made from the rise in the stock’s market price when you initially sold the put option.
Key Takeaway:
The Long Combo strategy allows you to take advantage of potential price movements in the underlying asset while limiting your risk by using a combination of call and put options. It can be a useful strategy for investors who have a bullish outlook but are uncertain about the asset’s direction in the short term. However, it’s essential to understand the risks involved and have a clear strategy in mind before implementing this or any other options trading strategy.