Also known as a long combination strategy, buying the call gives you the right to buy the stock at strike price A. Selling the put obligates you to buy the stock at strike price A if the option is assigned.

This strategy is referred to as synthetic long stock because the risk/reward profile is nearly identical to long stock. Furthermore, if you remain in this position until expiration, you will probably wind up buying the stock at strike A one way or the other. If the stock is above strike A at expiration, it would make sense to exercise the call and buy the stock. If the stock is below strike A at expiration, you’ll most likely be assigned on the put and be required to buy the stock.

Since you’ll have the same risk/reward profile as long stock at expiration, you might be wondering, Why would I want to run a combination instead of buying the stock? The answer is leverage. You can achieve the same end without the upfront cost to buy the stock.

 

Do it for the leverage

At initiation of the strategy, you will have some additional margin requirements in your account because of the short put , and you can also expect to pay a net debit to establish your position. But those costs will be fairly small relative to the price of the stock.

Most people who run a combination don’t intend to remain in the position until expiration, so they won’t wind up buying the stock. They’re simply doing it for the leverage.

It’s important to note that the stock price will rarely be precisely at strike price A when you establish this strategy. If the stock price is above strike A, the long call will usually cost more than the short put. So the strategy will be established for a net debit. If the stock price is below strike A, you will usually receive more for the short put than you pay for the long call. So the strategy will be established for a net credit.

Remember: The net debit paid or net credit received to establish this strategy will be affected by where the stock price is relative to the strike price.

 

What about dividends?

Dividends and carry costs can also play a large role in this strategy. For instance, if a company that has never paid a dividend before suddenly announces it’s going to start paying one, it will affect call and put prices almost immediately. That’s because the stock price will be expected to drop by the amount of the dividend after the ex-dividend date. As a result, put prices will increase and call prices will decrease independently of stock price movement in anticipation of the dividend.

If the cost of puts exceeds the price of calls, then you will be able to establish this strategy for a net credit. The moral of this story is: Dividends will affect whether or not you will be able to establish this strategy for a net credit instead of a net debit. So keep an eye out for them if you’re considering this strategy.

 

Maximum Potential Profit

There is a theoretically unlimited profit potential if the stock price keeps rising.

 

Maximum Potential Loss

Potential loss is substantial, but limited to strike price A plus the net debit paid or minus net credit received.

 

Break-even at Expiration

Strike A plus the net debit paid or minus the net credit received to establish the strategy.

 

Credence Global Bank Invest Margin Requirements

Margin requirement is the short put requirement. If established for a net credit, the proceeds may be applied to the initial margin requirement. After this position is established, an ongoing maintenance margin requirement may apply. That means depending on how the underlying performs, an increase (or decrease) in the required margin is possible. Keep in mind this requirement is subject to change and is on a per-unit basis. So don’t forget to multiply by the total number of units when you’re doing the math.

 

Time Decay

For this strategy, time decay is somewhat neutral. It will erode the value of the option you bought (bad) but it will also erode the value of the option you sold (good).

 

Implied Volatility

After the strategy is established, increasing implied volatility is somewhat neutral. It will increase the value of the option you sold (bad) but it will also increase the value of the option you bought (good).

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