Short Combination

The Short Combination is similar in nature to a Strangle.  The Short Combo entails selling Puts and Calls on the same underlying stock, with the same expiration, but with different strikes prices.  This credit spread strategy entails higher risk and requires margin.  The investor using this strategy expects the underlying stock to stay within a range during the life of the trade.  Let's have a look at the trade.

An investor feels BVF will trade within a range for a period of time and decides to implement a Short Combo.  BVF is trading at $20.  The investor sells 10 near-term BVF $22.50 Calls @$0.50 and sells 10 near-term BVF $17.50 Puts @ $0.50.  The investor receives $1 in combined premium for a total credit of $1,000.00.  

If BVF stays within the $17.50 to $22.50 range at expiration, the investor will maximize the return and both options will expire worthless in the account, leaving the $1,000.00 credit. 

If however, BVF trades outside the profit range, than this trade will be in a loss position.  The investor does not actually lose money until the stock trades outside the breakevens.   The upside breakeven on this trade is $23.50 (Call strike plus total premium received).  The downside breakeven on this trade is $16.50 (Put strike less total premium received).  The investor has unlimited loss potential above $23.50 and substantial loss potential below $16.50 (max loss if BVF goes to zero).

The investor needs to carefully monitor their breakeven points.  If the trades goes against the investor on either side, the investor may decide to "buy back" the side of the trade going against them.   This would still leave the other side of the trade open, still allowing for substantial risk if the stock where to reverse direction and go against the investor on the other side.  If being pushed on one side of the trade, the investor also has the choice of "buying back" both sides of the trade to close the trade entirely.  Strict trading discipline needs to be utilized with any "short" strategy.