Long Combo

The Long Combo strategy, also known as a synthetic long stock, is an options trading strategy used to simulate the payoff of owning a stock, but often at a lower cost. It involves buying a call option and selling a put option with the same expiration date and typically the same strike price. This strategy is designed to mimic the performance of a long stock position, giving the investor both the potential for unlimited gains and losses similar to owning the actual stock.

The Setup

Imagine you are bullish on XYZ Corporation, which is currently trading at $50 per share. To establish a long combo, you might:

Buy a call option with a strike price of $50 that costs $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.

Who Should Consider It

This strategy is suitable for investors who are very bullish on a stock and want to profit from its potential upside without actually purchasing the shares. It's ideal for those with a strong conviction that the stock will rise significantly before the expiration of the options.

Strategy Explained

By buying a call, you gain the right to purchase the stock at the strike price, capturing any upside beyond this level. Conversely, by selling a put, you take on the obligation to buy the stock at the strike price if it falls to that level or lower, essentially mirroring the risk and reward profile of stock ownership.

Breakeven Process

The breakeven point for a long combo is typically the strike price of the options used. Since the initial setup aims to be cost-neutral, the stock price must move above the strike price by the expiration for the position to profit, just like owning the stock.

Sweet Spot

The sweet spot for this strategy is when the stock price rises well above the strike price of the call and put options. The higher the stock price goes, the greater the potential profit.

Max Profit Potential

The maximum profit for a long combo is theoretically unlimited, as it mirrors the profit potential of being long on the underlying stock. As the stock price increases, the profits increase in a linear fashion.

Max Loss

The maximum loss is also substantial, akin to the losses one would face if holding the stock and it went to zero. If the stock price declines, particularly below the strike price of the put, the investor faces significant losses as they must buy the stock at the strike price, which could be higher than the market price.

Risk

The primary risk with a long combo is the stock's downside potential. Since this strategy mimics owning the stock, it carries similar downside risks, particularly as there's no cap on the potential losses if the stock price plummets.

Time Decay

Time decay (theta) impacts this strategy in that it can erode the value of the long call position over time if the stock price remains stagnant. However, this is offset by the benefit of time decay on the short put position, making the overall effect of time decay somewhat neutral, depending on the relative levels of implied volatility in the call and put.

Implied Volatility

Changes in implied volatility have a mixed impact on this strategy. Increased volatility generally increases the value of the call option more than it does the put option, potentially enhancing the strategy’s profitability if the stock price increases. However, if the stock price falls, higher volatility can increase losses as the value of the put option sold increases.

Conclusion

The long combo is a 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, it's important for traders to manage risk carefully, as this strategy exposes them to potentially unlimited losses similar to those associated with direct stock ownership.