COMBINATIONS:

A combination is an option trading strategy that involves taking a position in both calls and puts
on the same stock. The strategy of straddles, strips, straps and strangles is included in
combination.

Straddle:
The most popular combination is straddle, which involves buying a European call and put with
the same strike price and expiration date. This strategy is appropriate when an investor is
expecting a large move in a stock price but doesnt know in which direction the move will be.
The profit derived from straddle is shown in the following table and graph with the help of an
example.
Say,

the strike price, K = $70 (both call and put option); expiration date= 3 months (both)
The call cost, c = $3, the put cost, p = $4.
Here, the initial outflow is ($3+ $4) = -$7.

The payoff from straddle derived from different market prices are shown in the following table:

Range of stock price

69<K
63<K
55<K
77>K
90>K

Table no 12: Payoff from straddle

Payoff from call
Payoff from put
option
option
Will not exercise
$70-$69 = $1
Will not exercise
$70-$63 = $7
Will not exercise
$70-$55 = $15
$77-$70= $7
Will not exercise
$90-$70 = $20
Will not exercise

Total payoff
-$7+$1 = -$6
-$7+$7 = 0
$15-$7 = $8
-$7+$7 = 0
$20-$7 = $13

From the above table it can be seen that at price $63 and $77 the total payoff is 0. When the
market price is $90, then the profit will be $13 and it will be $8 if the market price will be $55.
The investor will able to make a profit if the price will be higher than $77 and lower than $63. In
the range of 63 to 77 there will be a cost for the investor. The maximum cost will be the initial
outflow which is $7 and there is no limit for the maximum profit.

The profit from straddle using a European call and put with the same strike price and expiration
date is shown in below:
Figure 12: Profit from a straddle

From
the

above graph it can be observed that when the price is $70 then here is a loss of $7, which is equal
to the initial investment. The amount of profit will be $8 when the price will be $55 and $85 and
there will be a loss if the price will be between $63 and $77.
This straddle is referred as a bottom straddle or straddle purchase. A top straddle or straddle write
is the reverse position. It is created by selling a call and put option with the same exercise price
and expiration date. It is highly risky strategy. If the stock price on the expiration date is close to
the strike price, a significant profit will be derived or vice versa.

Strips:
A strip consists of a long position in one European call and two European puts with the same
strike price and expiration date. In a strip the investor is betting that there will be a big stock
price move and considers a decrease in the stock price to be more likely than an increase. The
profit derived from strips is shown in the following table and graph with the help of an example.
Say,

the strike price, K = $70 (both call and put option); expiration date= 3 months (both)
The call cost, c = $3, the put cost, p = $4.
Here, the initial outflow is {$3+ ($4+$4)} = -$11.

The payoff from strip derived from different market prices are shown in the following table:
Table no 13: Payoff from strips
Range of stock
price
69<K

Payoff from call

option
Will not exercise

Payoff from put

option
$70-$69 = $1

63<K

Will not exercise

$70-$63 = $7

55<K

Will not exercise

$70-$55 = $15

77>K
90>K

$77-$70= $7
$90-$70 = $20

Will not exercise

Will not exercise

Total payoff
{-11+($1*2)} = $9
{-$11+($7*2)} =
$3
{-$11+($15*2)} =
$19
-$11+$7 = -$4
-$11+$20 = $9

From the above table it can be seen that at price $63 the total payoff is $3. When the market price
is $90, then the profit will be $9 and it will be -$9 if the market price will be $69. The investor
will able to make a profit if the price will be below $65.5 or if the price will be more than $81.
The maximum loss will be $11, which is the initial investment and there is no limit for maximum
profit.

The profit from strips using a European call and two put with the same strike price and
expiration date is shown in below:
Figure 13: Profit from a strip

From the above graph it can be observed that when the price is $70 then here is a loss of $11,
which is equal to the initial investment. The amount of profit will be $9 when the price will be
$60 and there will be a loss if the price will be between $65.5 and $81.

Straps:
A strap consists of a long position in two European call and one European puts with the same
strike price and expiration date. In a strap the investor is betting that there will be a big stock
price move and considers an increase in the stock price to be more likely than an decrease. The
profit derived from strap is shown in the following table and graph with the help of an example.
Say,

the strike price, K = $70 (both call and put option); expiration date= 3 months (both)
The call cost, c = $3, the put cost, p = $4.
Here, the initial outflow is {$4+ ($3+$3)} = -$10.

The payoff from strap derived from different market prices are shown in the following table:

Range of stock price

69<K
63<K
55<K
77>K
90>K

Table no 14: Payoff from straps

Payoff from call
Payoff from put
option
option
Will not exercise
$70-$69 = $1
Will not exercise
$70-$63 = $7
Will not exercise
$70-$55 = $15
$77-$70= $7
Will not exercise
$90-$70 = $20
Will not exercise

Total payoff
(-$10+$1) = -$9
(-$10+7) = -$3
(-$10+$15) = $5
{-$10+($7*2)} = $4
{-$10+($20*2)} = $30

From the above table it can be seen that at price $63 the total payoff is -$3. When the market
price is $90, then the profit will be $30 and it will be -$9 if the market price will be $69. The
investor will able to make a profit if the price will be below $60 or if the price will be more than
$75. The maximum loss will be $10, which is the initial investment and there is no limit for
maximum profit.
Figure 14: Profit from a strap

From the above graph it can be observed that when the price is $70 then here is a loss of
$10, which is equal to the initial investment. The amount of profit will be $20 when the price
will be $85 and there will be a loss if the price will be between $60 and $75.