Short Combo
Description
The
Short Combo is the precise opposite of a Long Combo. Instead of nearly
replicating the Long Stock (or Futures) position, we nearly replicate the Short
Stock (or Futures) position by buying OTM puts and selling OTM calls.
The
net result is a virtually nil cost or even net credit trade that has uncapped
risk potential as the stock rises.
Market
Opinion
Bearish.
P/L
When
To Use
Use
this strategy when you are in a bearish environment and wish to earn a capital
gain.
Example
XXXX
is trading at $35.10 on June 1, 2011.
Buy
August 2011 30 strike puts at $0.90.
Sell
August 2011 40 strike calls at $1.00
Benefit
With
this strategy, you use no capital and yet are able to simulate a short stock
position, and the ability to leg in and leg out as you wish.
Risk
vs. Reward
The
risk is uncapped if the stock rises, while the reward equals lower strike plus
net credit, or less net debit.
Net
Upside
Normally
a net credit.
Net
Downside
As
the stock rises, your risk is uncapped.
Break
Even Point
With
net credits: higher strike plus net credit.
With
net debits: lower strike minus net debit.
Effect
of Volatility
N/A
Effect
Of Time Decay
Positive.
You are reducing time decay by buying and selling near-the-money options, so
time decay is minimal.
Alternatives
Before Expiration
Always
close out the position before the last month of expiration.
To
stem a loss, sell if the stock increases up through the stop loss.
Alternatives
After Expiration
Close
the position by selling the puts and buying back the calls.
