Long Combo
Long combo is known also as synthetic long stock and can be referred to as the imitation of payback of an options trading strategy from owning a stock, although typically at a cheaper cost. In this case, a call option is purchased together with a sell of a put option at similar expiration and also usually of a similar strike. This strategy replicates the effect of a long stock position: it allows both unlimited gains as well as loss potential, both of which mimic the effect of owning the real stock.
The Long Combo Setup
You are positive about XYZ Corporation, which happens to be at $50 a share. For a long combo, you can do the following:
- Buy a call option, with a strike price of $50, priced at $3 per share.
- Sell a put option with the same strike price of $50, receiving a premium of $3 per share.
This setup typically results in a net zero cost for entering the trade, excluding transaction fees, because the cost of the call is offset by the premium received from selling the put.
This strategy is best-suited investors that are very bullish on a stock and would like to profit off of its upside potential without actually buying the shares. It is very effective for individuals with a high degree of conviction that the stock will run significantly before the expiration of the options.
This means that by buying a call, you acquire the right to buy the stock at the strike price, effectively capturing any upside that is beyond this level. On the other hand, when you sell a put, you commit to buying the stock at the strike price if it moves to that level or below, which reflects effectively the same risk-and-reward profile of stock ownership.
The breakeven point of a long combo is usually at the strike of the options purchased. Since a cost-neutral beginning is desired for the initial position, the stock price needs to be above the strike price by expiration for this position to start making money as if it was owning the stock.
This strategy sweet spot is when the stock price has risen beyond the strike price of both the call and put options. The higher the price goes, the more profit potential exists.
The theoretical maximum profit for a long combo is unlimited, as it reflects the profit potential of being long on the underlying stock. As the stock price moves higher, profits are linear.
The amount lost is also high, similar to what that person would lose if holding the stock and it became worthless. For example, when the stock price deteriorates, especially down below the put strike, the investor loses much money because they have to purchase the stock at the strike price, which could be above the market price.
The main risk associated with a long combo is the stock’s downside potential. Since this is a strategy mimicking an ownership of the stock, similar downside risks exist, but there is no cap on the potential loss if the stock price plunges.
Time decay (theta) affects this strategy in that, if the stock price does not move, the long call will lose value with time. The benefit of the short put’s time decay works to counter this effect, though, and, depending on how much more volatility is implied in the call compared to the put, the impact of time decay is somewhat muted.
On the other hand, changes in implied volatility have a mixed effect on the strategy. High volatility provides more incremental value to a call option rather than to the put option sold. In case the stock price rises, then profitability shall be enhanced. Conversely, if the stock prices deteriorate, then the loss on the strategy is heightened due to an increased put option sold value.
The long combo is a very powerful strategy for bullish investors who want the full upside potential of stock ownership without the initial capital outlay required to buy the stock outright. However, traders should be careful about managing risk, as this strategy exposes them to potentially unlimited losses similar to those associated with direct stock ownership.