What are combination trades?
These strategies can also be done when trading on eToro or other brokerages out there. Combination trading is the act of simultaneously buying and selling options on an underlying asset to take advantage of forecasting market behaviour.
Unlike traditional long or short positions, you can profit from both bullish and bearish behaviours in the markets with a combination trade.
How do they work?
Let’s imagine that Company A is expected to release its quarterly report next Wednesday. The share price has been slowly creeping up in anticipation, but there is significant room for movement throughout next week; it could peak at $50 or fall to $40. So, you decide to place combination trades by buying two call contracts (betting on the price rising) and writing (selling) 2 number 40 put options (betting on the price falling).
It gives you a position where you will make money regardless of which direction the stock moves; if it goes up, your call options will be in the capital, and you’ll make a profit on those contracts. If it falls, your put options will be in-the-money, meaning you receive the premium from writing them, plus the underlying shares will be worth more than when you bought them, meaning you still make a profit.
What are the risks?
There is always some risk associated with any investment, and combination trades are no different. The main risk comes from being wrong about which direction the market will move; if Company A’s report disappoints investors and the stock falls below $40, then you’ll lose money from the value of both the number 40 put options and the underlying stock.
Another risk is that Company A’s quarterly report could turn out better than expected. Leading to an increased share price beyond $50 per share; in this case, your written (sold) put options will cost more than the total amount you receive for selling your call contracts and will result in a loss.
Thus it is essential to understand the markets and what moves them before engaging in combination trades, as no strategy can guarantee positive returns.
How can I use them?
Combination trades are helpful when there is a high degree of uncertainty about how markets will react, such as during political or economic events or just before quarterly financial statements are released.
It is also possible to use combination trades to hedge your existing share portfolio. If you own shares in Company A, then by creating combination trades that act as insurance against the price falling, you would be able to defer some of the losses if their quarterly report fell short.
Can I start using them today?
Yes! Although various platforms are available online for trading options and other assets, these all allow you to trade combinations with relative ease. So why not give it a try? Make sure you first understand how futures contracts work, how trends impact the markets and what factors make one currency more volatile than another. This knowledge will help you avoid costly mistakes before making your first combination trades.
When using combination trades, the main thing is to have a plan; if you know what events make the markets move and which direction they most likely will, you can use your knowledge to create profitable trading strategies.
The basics of combination trading are relatively straightforward: work out how the assets will react to specific events and where the prices will go next and implement them in your trading strategy. The more complicated part comes from actually understanding these concepts.
Since there is no “right” or “wrong” regarding market behaviour, using knowledge about past trends, events, and their impact on the financial world helps traders develop a strong intuition for when volatility may occur. Combine this with some basic option theory and technical analysis, and you’ll be ready to trade options in the UK and make some excellent trades!
Combination trades can be highly favourable if used correctly; make sure you know what will happen next and how markets react to certain events. With enough knowledge, you’ll be trading like a professional in no time.