Covered Combination Option Spread Profit Loss Graph
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Buy shares of the underlying security |
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Sell a near term OTM call (no more than 2 strikes out). |
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Sell the same number of near term OTM puts (no more than 2 strikes out). |
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The net investment is the overall net debit (stock price - total net credit). |
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The maximum profit occurs at assignment of the short call (stock appreciation + net credit). |
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The maximum risk occurs if the stock drops to 0 ([Loss on stock + Put buy back cost] - total premium). |
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The break even is the stock price minus the premiums received.* |
| Net Credit = | Call Premium + Put Premium |
| Downside Protection = | Net Credit ÷ Stock Price |
| Max Risk = | (Stock Price + Put Strike) - Net Credit (if Stock Drops to 0) |
| Max Profit = | Return if Assigned on Short Call where: |
| % If Assnd (Call) = | [Net Credit + Appreciation on Stock] ÷ [Stock Price - Net Credit + Put Strike] |
Where Appreciation on Stock = Call Strike - Stock Price |
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| % If Assnd (Put) = | [Net Credit - Depreciation on Stock] ÷ [Stock Price - Net Credit + Put Strike] |
Where Depreciation on Stock = Stock Price - Put Strike |
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| % If Unchanged = | Net Credit ÷ (Stock Price - Net Credit + Put Strike) |
| * Break Even = | Stock Price - Net Credit |
When the total Net Credit is less than the difference of Stock Price - Put Strike Price |
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--OR-- |
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| * Break Even = | [{(Put Strike) - (Stock Price - Net Credit)} ÷ 2] + (Stock Price - Net Credit) |
| If the total Net Credit is greater than the difference of Stock Price - Put Strike. The second Break Even calculation reflects the potential buy back cost of the Short Put if the stock drops. | |
| Example: | Stock XYZ at $40.04 per share. |
| Buy 100 shares XYZ at $40.04 | |
| Write (Sell) the MAY 42.5 Strike Call @ $1.15 | |
| Write (Sell) the MAY 37.5 Strike Put @ $1.10 | |
| Total Net Credit = | ($1.15) + ($1.10) = $2.25 |
| Downside Protection = | $2.25 ÷ $40.04 = 5.6% |
| Max Risk = | ($40.04 + $37.50) - $2.25 = $75.65 (if Stock goes to $0) |
| Max Profit = | $2.25 + $2.46 = $4.71 |
| % Return if Assigned (Call) = | ($2.25 + $2.46) ÷ ($40.04 - $2.25 + 37.5) = 6.2% |
| % Return if Assigned (Put) = | ($2.25 - $2.54) ÷ ($40.04 - $2.25 + 37.5) = -0.38% |
| % If Unchanged = | $2.25 ÷ ($40.04 - $2.25 + 37.5) = 2.9% |
| Break Even = | $40.04 - $2.25 = $37.79 |
| Since the Net Credit is less than (Stock Price - Put Strike), the first Break Even equation applies. If the Net Credit in this example was greater than (Stock Price - Put Strike), we would apply the second Break Even equation. | |
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Greater combined net credit increases downside protection and potential return. |
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Assignment on OTM call allows investor to lock in higher profits |
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Combinations can be profitable in sideways or rising markets. |
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If shares of stock are put to the investor, they receive the shares at a discount and can easily sell calls against the new shares increasing covered call potential. |
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Losses are limited in the combination option strategy if the stock goes against you one way or the other. |
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Limited Maximum Profit on the upside. |
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Reserve funds may be needed in order to cover the sale of the short put. |
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If the stock drops suddenly, the investor may have the stock put to them early. |
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Covered Combinations should only be traded on stocks that are bullish. |
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If the stock continues to drop, the investor may need to liquidate the position to avoid further losses. |
