Option combination strategies

Besides buying or selling single options, there are many other possible strategies that involve positions in multiple options simultaneously, as well as combining options with positions in the underlying assets. While there are infinite combinations possible, we start with two common combinations below.

Protective put

A protective put is a strategy that can be used to insure a stock portfolio against losses. The investor combines a long position in the underlying asset with a long put option. The long put option position caps any potential loss caused by a drop in the share price, as the investor will be able to exercise the put option at the strike price and lock in the sell price, only losing the premium paid.

Covered call

A covered call is constructed by combining a long position in the underlying asset with writing a call option against the same asset. By selling the call option, the investor receives an option premium. This guaranteed income offers a small downside protection; if a decline in the underlying price is lower than or equal to the amount of option premium received, the total position does not return a loss. In return, the investor caps the profit potential by agreeing to sell the shares at the strike price. As such, this strategy works well if the investor expects little change in the price of the underlying asset  or has determined an exit level for their investment at which they are happy to sell.