The term combination refers to an options strategy involving trades that take a position in both call and put options for the same underlying security. Option combinations allow investors to construct trades that balance risk and reward with their risk profile.
While the term combination can refer to any grouping of financial contracts, it’s oftentimes used when referring to options. Specifically, an options combination can refer to a strategy that consists of the purchase and / or sale of both calls and puts for the same underlying security. Collars and straddles are two examples of combinations.
- Collars: involves the purchase of an out-of-the-money put, which protects the underlying securities from a loss due to a price decline and the sale of an out-of-the-money call, which helps offset the price paid when buying the put.
- Straddles: involves the purchase of an equal number of call and put options, with the same expiration date, identical strike prices, and using the same underlying security. Straddles provide the investor with unlimited profit potential, while limiting risk.