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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

 

Description: http://www.avasaram.com/images/strategies/PLSP/ShortCombo.png 

 

 

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.

 
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