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Stock Repair Strategy

Stock Repair Option Graph

"Stock Repair" or "Stock Rescue" are names given to an option strategy that is designed to lower your breakeven price on a stock position. In other words, by using options, you make enough of a gain on the options to be able to sell your stock at a loss, but break even overall.

Unlike trying to "bottom fish" or "average down", the option strategy can often be done with no additional risk of capital, or sometimes a slight additional risk. The strategy normally will not do much better than breakeven overall, so your risks are that you give up any possible gains in the stock, and you will still have a loss if the stock does not rise enough.

Here are the steps you need to take:

  1. Give up on the stock getting back to your buy price any time soon. If you think the stock alone might get back to breakeven or better, then just wait for that to happen.
  2. The stock must have a reasonable chance of reaching the OTM strike price in step 4 by the expiration date. A stock you bought at $30, and is now at $25, has a reasonable chance of reaching $27.50 in three months. If your stock has fallen to $5, you won't be able to break even at any strike price. If that is the case, you could target $10, and just be happy to do that much better than selling at $5. Or just wait for the stock to recover enough to make the breakeven strike price reasonable.
  3. Buy one ATM call expiring in three months or more, for each hundred shares of stock you own.
  4. Sell twice that many OTM calls with the same expiration date as the long call(s).
  5. The two OTM calls you sell should bring in about as much premium as you spend on the one long call, thus allowing you to enter the position at little or no cost. This is dependent on the implied volatility of the options. A higher IV makes it more likely that you can enter at no cost or even a credit. Also, options expiring in just one or two months probably won't allow you to enter the trade at no cost.
  6. As far as your broker is concerned, your position will consist of covered call(s), which almost everyone has permission to do, and bull call(s). If you don't already have permission to trade spreads like bull calls, arrange that with your broker first, usually by filling out an application.
  7. There is a partial workaround if you do not have permission to trade spreads like bull calls and your broker will not grant permission anytime soon, as long as you do have permission to trade covered calls and long calls. You can sell OTM covered calls against all of your stock holdings, and buy half that number of ATM long calls. For instance, if you have 1000 shares, sell ten OTM calls against the stock, and buy five ATM long calls. This will allow you to get out of half your position at breakeven if the stock moves favorably. And as a matter of fact, if the position does reach breakeven on half the shares, you are in a better position to gain on the other half. So you might consider this strategy if you think there is some possibility of your stock recovering on it's own.

The theory and results of this trade can be shown as follows:

  • Cost of 1000 shares of stock at $30 = $30,000.00
  • With stock at $25, showing a $5,000 loss: Buy ten 25 strike calls expiring in three months, IV 40%: $1.98 each = $1980.00 debit
  • Sell twenty 27.5 strike calls expiring in three months, IV 40%: $1.04 each = $2080.00 credit
  • Overall credit on options = $100.00

Stock at or over $27.50 on expiration date in three months:

  • Ten short calls call you out of stock at $27.50, but you keep premium of $1.04, (2.5-1.04)x1000 = loss of $1460.00
  • Ten bull call spreads make difference in strike prices, less initial debit = (2.5-.94)x1000 = $1560.00
  • Overall gain or loss at $27.50 or above = $100.00

If stock is at exactly $27.50 on expiration date, you do $2.50x1000 + $100.00 better = $2600.00 better than just holding stock.

If stock is at $30.00 on expiration date, you do $100.00 better than just holding stock.

If stock is at $32.50 on expiration date, you do $100.00 - $2.5x1000 = $2400.00 worse than holding stock, but the loss is a loss of opportunity, not cash.

The graph below shows the position if you are only able, or only want to write short calls to take you out of half the stock. Notice that if the stock exceeds your goal and gets back to 30, the position does as well as holding the stock alone.

 

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