A long combo is a bullish strategy. If an investor expects the price of a stock to move up, they can use a long combo strategy. It involves selling an OTM Put (OTM - Out Of The Money, i.e., when the Put Option's strike price is lower than the prevailing market price of the underlying stock) and buying an OTM Call (OTM - Out Of The Money, i.e., when the Call Option's strike price is higher than the prevailing market price of the underlying stock).
This strategy simulates the action of buying a stock (or futures) but at a fraction of the stock price. It is an inexpensive trade, similar in pay-off to long Stock, except there is a gap between the strikes (please see the payoff diagram). As the stock price rises, the strategy starts making profits. Let us try and understand the long combo with an example.
When to Use: The investor is bullish on the stock.
Risk: Unlimited (Lower strike + net debit)
Reward: Unlimited
Breakeven: Higher strike + net debit
Example:
ABC Ltd. is trading at ₹450. Mr. XYZ is bullish on the stock but does not want to invest ₹450. He executes a long combo by selling a Put Option with a strike price of ₹400 at a premium of ₹1 and buying a Call Option with a strike price of ₹500 at a premium of ₹2. The net cost of the strategy (net debit) is ₹1.