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Stock Enhancement Strategy

Stock Enhancement Option Graph

Stock enhancement is the exact same strategy as the "stock repair" strategy, except you are not trying to break even on a stock position at a lower price than the purchase price, you are trying to get an extra gain at a level above your purchase price. See the "stock repair" page for details about the strategy as used for that purpose.

A stock enhancement might work as follows: You purchase 1000 shares of a stock at $30, spending $30,000.00, and of course you are bullish on the stock. You think it has a chance of reaching $32.50 or above in three months.

In order to maximize your gains at that level, with no additional outlay of capital, you do the following:

  1. Buy ten 30 strike calls expiring in three months, IV 33%, for $1.97 = $1970.00 debit.
  2. Sell twenty 32.5 strike calls expiring in three months, IV 33%, for $1.02 = $2040.00 credit.

The results of this trade if the stock does reach $32.50 or above at expiration are as follows:

  • Cost of 1000 shares of stock at $30 = $30,000.00
  • With stock at $30.00, add the option position as shown in steps 1 & 2, for a $70.00 credit on the options.
  • With stock at or over $32.50 on the expiration date in three months:
  • Ten short calls call you out of stock at $32.50, plus you keep premium of $1.02, (2.5+1.02)x1000 = gain of $3520.00
  • Ten bull call spreads make difference in strike prices, less initial debit = (2.5-.95)x1000 = $1550.00
  • Overall gain or loss at $32.50 or above = $5070.00

If stock is at exactly $32.50 on expiration date, you do $5070-$2500 = $2570.00 better than owning stock alone.

If stock is at $30.00 or below on expiration date, you do $70.00 better than just holding stock, although you may have an unrealized loss on the stock.

If stock is at $35.00 on expiration date, you do $5070-$5000 = $70 better than just holding stock.

Anywhere over $35.07 you have a loss of opportunity.

In this particular example, adding the stock enhancement resulted in slightly better gains at your target price of $32.50 then you would have on the stock alone if it went to $35.00.

Remember you still have plenty of downside risk if the stock drops below 30. And you have a loss of opportunity if the stock happens to go over $35.07.

Anytime you are considering the stock enhancement strategy, you might want to compare it to just a bull call, a calendar call, or a butterfly targeting the same short strike. You will get a tremendous reduction of risk and capital outlay, but keep good gains if the stock moves as you expect.

 

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