Option trade repair

Option Trading Subjects:
Stock Repair Strategy.
"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:
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. 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. Buy one ATM call expiring in three months or more, for each hundred shares of stock you own. Sell twice that many OTM calls with the same expiration date as the long call(s). 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. 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. 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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Fix Broken Trades With The Repair Strategy.
Investors who have suffered a substantial loss in a stock position have been limited to three options: "sell and take a loss", "hold and hope", or "double down". The "hold and hope" strategy requires that the stock return to your purchase price, which may take a long time if it happens at all.
The "double down" strategy requires that you throw good money after bad in hopes that the stock will perform well. Fortunately, there is a fourth strategy that can help you "repair" your stock by reducing your break-even point without taking any additional risk. This article will explore that strategy and how you can use it to recover from your losses.
Defining The Strategy.
The repair strategy is built around an existing losing stock position and is constructed by purchasing one call option and selling two call options for every 100 shares of stock owned. Since the premium obtained from the sale of two call options is enough to cover the cost of the one call options, the result is a "free" option position that lets you break even on your investment much more quickly.
Here is the profit-loss diagram for the strategy:
How To Use The Repair Strategy.
Let's imagine that you bought 500 shares of XYZ at $90 not too long ago, and the stock has since dropped to $50.75 after a bad earnings announcement. You believe that the worst is over for the company and the stock could bounce back over the next year, but $90 seems like an unreasonable target. Consequently, your only interest is breaking even as quickly as possible instead of selling your position at a substantial loss. (For more strategies to get back on track, read What To Do When Your Trade Goes Awry .)
Constructing a repair strategy would involve taking the following positions:
Purchasing 5 of the 12-month $50 calls. This gives you the right to purchase an additional 500 shares at a cost of $50 per share. Writing 10 of the 12-month $70 calls. This means that you could be obligated to sell 1,000 shares at $70 per share.
Now, you are able to break even at $70 per share instead of $90 per share. This is made possible since the value of the $50 calls is now +$20 compared to the -$20 loss on your XYZ stock position. As a result, your net position is now zero. Unfortunately, any move beyond $70 will require you to sell your shares. However, you will still be up the premium you collected from writing the calls and even on your losing stock position earlier than expected.
A Look At Potential Scenarios.
So, what does this all mean? Let's take a look at some possible scenarios:
XYZ's stock stays at $50 per share or drops.
Determining Strike Prices.
One of the most important considerations when using the repair strategy is setting a strike price for the options. This price will determine whether the trade is "free" or not as well as influence your break-even point.
You can start by determining the magnitude of the unrealized loss on your stock position. A stock that was purchased at $40 and is now trading at $30 equates to a paper loss of $10 per share.
The option strategy is then typically constructed by purchasing the at-the-money calls (buying calls with a strike of $30 in the above example) and writing out-of-the-money calls with a strike price above the strike of the purchased calls by half of the stock's loss (writing $35 calls with a strike price of $5 above the $30 calls).
Start with the three-month options and move upwards as necessary to as high as one-year LEAPS. As general rule, the greater the loss accumulated on the stock, the more time will be required to repair it. (Keep reading about LEAPS in Using LEAPS In A Covered Call Write .)
Some stocks may not be possible to repair for "free" and may require a small debit payment in order to establish the position. Other stocks may not be possible to repair if the loss is very substantial - say, greater than 70%.
It may seem great to break even now, but many investors leave unsatisfied when the day comes. So, what about investors who go from greed to fear and back to greed? For example, what if the stock in our earlier example rose to $60 and now you want to keep the stock instead of being obligated to sell once it reaches $70?
Luckily, you can unwind the options position to your advantage in some cases. As long as the stock is trading below your original break-even (in our example, $90), it may be a good idea so long as the prospects of the stock remain strong.
It becomes an even better idea to unwind the position if the volatility in the stock has increased and you decide early in the trade to hold on to the stock. This is a situation in which your options will be priced much more attractively while you are still in a good position with the underlying stock price.
Problems arise, however, once you try to exit the position when the stock is trading at or above your break-even price: it will require you to fork over some cash, since the total value of the options will be negative. The big question becomes whether or not the investor wants to own the stock at these prices.
In our previous example, if the stock is trading at $120 per share, the value of the $50 call will be $70, while the value of the two short calls with strike prices of $70 will be -$100. Consequently, reestablishing a position in the company would cost the same as making an open-market purchase ($120) - that is, the $90 from the sale of the original stock plus an additional $30. Alternatively, the investor can simply close out the option for a $30 debit.
As a result, generally you should only consider unwinding the position if the price remains below your original break-even price and the prospects look good. Otherwise, it is probably easier to just re-establish a position in the stock at the market price.
The repair strategy is a great way to reduce your break-even point without taking on any additional risk by committing additional capital. In fact, the position can be established for "free" in many cases.
The strategy is best used with stocks that have experienced losses from 10% to 50%. Anything more may require an extended time period and low volatility before it can be repaired. The strategy is easiest to initiate in stocks that have high volatility, and the length of time required to complete the repair will depend on the size of the accrued loss on the stock. In most cases, it is best to hold this strategy until expiration, but there are some cases in which investors are better off exiting the position earlier on.

"Repairing Losing Long Call Options?"
Question By Kevin Ho.
Find Out How My Students Make Money Consistently Through Options Trading In The US Market Even During An Economic Downturn!
Answered by Mr. OppiE.
Options are the most versatile trading instrument in the world today. It offers not only a myriad of ways to profit from a single or multiple outlook but is also versatile enough to be transformed to accomodate changing outlooks as the trade progresses in order to limit losses or even turn around a losing options trading position.
Example of Transforming Long Call Into Synthetic Put.
Example of Transforming Long Call Into Bear Call Spread.
In conclusion, there are many ways to repair losing positions in options trading but you will need to make sure your outlook on the new direction is correct and make sure you calculate the new resultant breakeven point and maximum loss in order to decide if such an adjustment is worth it.
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What To Do When Your Options Trade Goes Awry.
Successful options trading is not about being correct most the time, but about being a good repair mechanic. When things go wrong, as they often do, you need the proper tools and techniques to get your strategy back on the profit track. Here we demonstrate some basic repair strategies aimed at increasing profit potential on a long call position that has experienced a quick unrealized loss.
Defense Is Just as Important as Offense.
Repair strategies are an integral part of any trading plan. I always review a well thought-out set of "what-if" scenarios before putting any money at risk. Too often, though, beginner options traders give little thought to potential follow-up adjustments or possible repair strategies before establishing positions. Having a great strategy is important, but making a profit is highly correlated with how well losing trades are managed. "Play good defense" is my options-trading mantra.
Fixing a Long Call.
Many traders will buy a simple call or put only to find that they were wrong about the expected movement of the underlying stock. An out-of-the-money long call position, for example, would experience immediate unrealized losses should the stock drop. What should the trader do in this situation?
Let's examine a simple long call example, which demonstrates a concept that you can apply also to a long put. Suppose it is currently the middle of February and we believe that IBM, which at 93.30, is poised to make a move above resistance (the upper green line in Figure 1) at about 95. We have good reason to jump in early with the purchase of a July 95 near-the-money call. With about 150 calendar days left until expiration, there is plenty of time for the move to occur.
But suppose, not long after we enter the position, IBM gets a downgrade and drops suddenly, perhaps even below medium-term support at 91.60 (the lower green line in Figure 1) to about 89.34. The price of the July 95 call would now be worth about $1.25 (assuming some time-value decay), down from $3, rendering an unrealized loss of $175 per option. Figure 2 presents the profit/loss profile of this trade.
With so much time remaining until expiration, however, it's still possible that IBM may reach and surpass the strike price of 95 by Jul 16, but waiting could add additional losses and present additional opportunity costs, which result from our forgoing any other trade with profit potential during the same period.
One way to address unrealized loss is to average down by purchasing more options, but this only increases risk should IBM keep falling or never return to the price of 95. Actually, the breakeven on the original July 95 call, which was purchased for $3, is 98. This means that the stock would have to rise by nearly 10% to get to the breakeven point. Averaging down by purchasing a second option with a lower strike price, such as the July 90 call, lowers the breakeven point, but adds considerable additional risk, especially since the price has broken below a key support level of 91.60 (indicated in Figure 1).
One simple method to lower the breakeven point and increase the probability of making a profit without increasing risk too much is to roll the position down into a bull call spread. This is a strategy presented by options educator, Larry McMillan, in his book, "Options as a Strategic Investment", a must-have standard reference on options trading.
To implement this method we would place an order to sell two of the July 95 calls at the new price of $1.25, which amounts to going short the July 95 call option since we are long one option already (selling two when we are long one, leaves us short one). At the same time, we would buy a July 90 call, selling for about 2.90. Table 2 presents the price details:
The net result of this adjustment into a bull call spread is that our total risk has increased only slightly, from $300 to $325 (not counting commissions). But our breakeven point has been lowered considerably from 98 to 93.25, a drop of 4.75%.
Suppose now that IBM manages to trade higher, back to the starting point of 93.30. Our bull call spread would now be just above breakeven, with a potential profit as high as 95, although limited to just $175 per option. We have, therefore, lowered our breakeven point without adding much additional risk, which makes good sense.
Alternative Repair Approach.
Another repair attempt (which can perhaps be combined with the one above) is to roll down into a butterfly spread when IBM falls to 90. With this strategy we sell two July 90 calls, which would be going for about $4 each, and keep the July 95 long call, and then buy a July 85 call for about $7.30 (assuming a little bit of time-value decay in these numbers).
The total risk actually decreases on the downside since the total debits fall to $230, but there is some limited upside risk should IBM move back above 92.65 (breakeven). If IBM goes nowhere, however, the trade actually produces a nice profit, occurring between 87.30 and 92.65. The profit/loss table below presents our different scenarios for this repair strategy:
Meanwhile, maximum potential losses are $235 (upside) and $225 (downside). Maximum potential profit is at 90 with $264, and profit decreases marginally as you move toward the upper and lower breakeven points, as seen in Figure 3.
Combining the Repair Strategies.
Since this is a butterfly spread, maximum profit by definition is at the strike of the two short calls (July 90 calls), but movement away from this point eventually leads to losses. Therefore, the best overall approach might be to mix our two repair strategies in a multi-lot repair approach. This combination can preserve the best odds of producing a profit from a potential loser: the bull call-spread repair has a profit from 93.25 up to 95. And, there are ways to adjust a butterfly spread given moves of the underlying (a topic that would require a separate article).
We've looked at two ways (which might best be combined) to adjust a long call position gone awry. The first involves rolling down into a bull call spread, which significantly lowers overhead breakeven while preserving reasonable profit potential (albeit this potential is limited, not unlimited as in the original position). The cost poses only a tiny increase in risk. The second approach is to roll into a butterfly spread by keeping our original July call, selling two at-the-money call options and buying an in-the-money call option. Whether used alone or in tandem, these repair strategies offer some flexibility in your trading plans.
There will always be losses in options trading, so each trade must be evaluated in light of changing market conditions, risk tolerance and desired objectives. That said, by properly managing the potential losers with smart repair strategies, you stand a better chance of winning at the options game in the long run.