After gaining some experience in options trading, you may want to try something different. One idea is the use of combination trades. A combination trade begins with one trade, and then another trade can be added by either adding another transaction or using protective puts. The goal of combination trades is to create more substantial moves in the stock, resulting in more significant profits.
To begin a combination trade, two transactions are needed simultaneously. For example, if XYZ stocks are trading at $25, buy ten contracts for 100 shares each ($2500 total investment). Then sell five contracts of 30 days out for XYZ stock when trading at $27 ($1000 profit). With this transaction alone, there would be a net profit of$500.
Once you sell options, it is always possible that the stock could increase more than expected and create a loss instead of a gain like in the example above. A protective put can limit this risk by creating an artificial cap on how low the stock can fall before it gains value again. For example, buy five contracts of XYZ stock at $27 (sells ten contracts for 30 days out), and buy one contract of XYZ 30 days out with a strike price of $30 (sells three contracts).
The total spend would be $2700, and there will be no less than $30 per share earned from either trade. With this combination, if the stock increased to $31 overnight, only the stock would be worth $31. With the mix, there will still be a maximum profit of $3000 from either trade with an investment of only $2700.
Another way to use combination trades is by using seasonal trends to your advantage. For example, many companies have many puts and calls placed for their stocks in August due to vacation time and end-of-summer bonuses. It creates a high volume of short-term contracts, creating ideal trading opportunities.
A company like GE typically has many options trading on their stock during this month because so many traders know that employees have received 4th quarter bonuses since the 1980s. These bonus earnings from older employees result in buying the underlying stock within a week or two before the bonus date, which increases GE stock movement.
No matter what type of combination trade you would like to create, options trading is a fantastic way to access unlimited opportunities. When it comes time for options expiration, remember some important rules if you have made a combination trade. If these rules are not followed, the broker could consider your transaction invalid and re-opened.
Tips when it comes time for the expiration
- Both transactions need to be closed out at the same time
- Never close out one side of a position if they plan on holding the other half
- Never use the cash received from closing one position to open another one
- If you cannot follow the previous rules, make sure all contracts expire simultaneously and not on different days.
- Use saxotrader to manage all your transactions.
Suppose these basic options expiration rules are followed, and your combination trade has increased in value over time. In that case, it will likely decrease as more traders become aware of its success. It can lead to an excellent opportunity for a new entry point with a lower price per share or may create a good enough reason to allow the position to expire out of the money with a 100% loss of total investments.
Whatever option is chosen, it would be wise to stick with one decision from beginning to end. Sometimes patience is critical when creating combination trades so you can be sure they will have maximum potential during expiration.
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