##### Covered Combination Help
###### Covered Combination Option Spread Profit Loss Graph The Covered Combination is a Neutral to Bullish strategy. In a Covered Combination an investor will buy shares of the underlying security and then sell At-the-Money (ATM) or Out-of-the-Money (OTM) call(s) and at the same time sell the same number of OTM put(s). The Covered Combination could also be referred to as a Covered Short Strangle. By selling the same number of OTM call(s) and OTM put(s), an investor will increase the premiums received from the options thus increasing the potential return and downside protection as compared to a standard ATM or OTM covered call. This helps the investor potentially maximize profit. If the stock does drop slightly, the investor might have more stock put to them at a favorable price (Put strike price).
 Buy shares of the underlying security Sell a near term OTM call (no more than 2 strikes out). Sell the same number of near term OTM puts (no more than 2 strikes out). The net investment is the overall net debit (stock price - total net credit). The maximum profit occurs at assignment of the short call (stock appreciation + net credit). The maximum risk occurs if the stock drops to 0 ([Loss on stock + Put buy back cost] - total premium). The break even is the stock price minus the premiums received.*
##### Calculations for the Combination Spread Strategy are:
Downside Protection = Net Credit Ã· 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] Ã· [Stock Price - Net Credit + Put Strike]
##### Where Appreciation on Stock = Call Strike - Stock Price
% If Assnd (Put) = [Net Credit - Depreciation on Stock] Ã· [Stock Price - Net Credit + Put Strike]
##### Where Depreciation on Stock = Stock Price - Put Strike
% If Unchanged = Net Credit Ã· (Stock Price - Net Credit + Put Strike)
* Break Even = Stock Price - Net Credit
##### --OR--
* Break Even = [{(Put Strike) - (Stock Price - Net Credit)} Ã· 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 Ã· \$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) Ã· (\$40.04 - \$2.25 + 37.5) = 6.2%
% Return if Assigned (Put) = (\$2.25 - \$2.54) Ã· (\$40.04 - \$2.25 + 37.5) = -0.38%
% If Unchanged = \$2.25 Ã· (\$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.