Covered Combination
Covered Combination
The covered combination, also known as the covered strangle, is a limited profit, unlimited risk strategy in options trading that involves selling equal number of out-of-the-money calls and puts of the same underlying security, strike price and expiration date while owning the underlying stock.
Covered Combination Construction
Long 100 Shares
Sell 1 OTM Call
Sell 1 OTM Put
Limited Profit Potential
Maximum gain for the covered combination is achieved when the underlying stock price on expiration date is trading at or above the strike price of the call options sold. This is the price where the trader's long stock gets called away for a profit plus he gets to keep all of the initial credit received when he entered the trade.
The formula for calculating maximum profit is given below:
Max Profit = Strike Price of Short Call - Purchase Price of Underlying + Net Premium Received - Commissions Paid
Max Profit Achieved When Price of Underlying >= Strike Price of Short Call
Covered Combination Payoff Diagram
Unlimited Risk
Large losses can be experienced when writing a covered combination when the underlying stock price makes a strong move downwards below the breakeven point at expiration. This strategy loses money twice as fast as a regular covered call write as the covered combination loses not only on the long stock position but also on the short put.
The formula for calculating loss is given below:
Maximum Loss = Unlimited
Loss Occurs When Price of Underlying < (Purchase Price of Underlying + Strike Price of Short Put - Net Premium Received) / 2
Loss = Purchase Price of Underlying + Strike Price of Short Put - (2 x Price of Underlying) - Max Profit + Commissions Paid
Breakeven Point(s)
The underlier price at which break-even is achieved for the covered combination position can be calculated using the following formula.
Breakeven Point = (Purchase Price of Underlying + Strike Price of Short Put - Net Premium Received) / 2
The covered combination, also known as the covered strangle, is a limited profit, unlimited risk strategy in options trading that involves selling equal number of out-of-the-money calls and puts of the same underlying security, strike price and expiration date while owning the underlying stock.
Covered Combination Construction
Long 100 Shares
Sell 1 OTM Call
Sell 1 OTM Put
Limited Profit Potential
Maximum gain for the covered combination is achieved when the underlying stock price on expiration date is trading at or above the strike price of the call options sold. This is the price where the trader's long stock gets called away for a profit plus he gets to keep all of the initial credit received when he entered the trade.
The formula for calculating maximum profit is given below:
Max Profit = Strike Price of Short Call - Purchase Price of Underlying + Net Premium Received - Commissions Paid
Max Profit Achieved When Price of Underlying >= Strike Price of Short Call
Covered Combination Payoff Diagram
Unlimited Risk
Large losses can be experienced when writing a covered combination when the underlying stock price makes a strong move downwards below the breakeven point at expiration. This strategy loses money twice as fast as a regular covered call write as the covered combination loses not only on the long stock position but also on the short put.
The formula for calculating loss is given below:
Maximum Loss = Unlimited
Loss Occurs When Price of Underlying < (Purchase Price of Underlying + Strike Price of Short Put - Net Premium Received) / 2
Loss = Purchase Price of Underlying + Strike Price of Short Put - (2 x Price of Underlying) - Max Profit + Commissions Paid
Breakeven Point(s)
The underlier price at which break-even is achieved for the covered combination position can be calculated using the following formula.
Breakeven Point = (Purchase Price of Underlying + Strike Price of Short Put - Net Premium Received) / 2