How Does The Stock Repair Strategy Work in Options Trading?
Stock Repair Strategy - Definition
An options trading strategy designed to quickly recover value loss from a drop in share price using stock options.
Stock Repair Strategy - Introduction
The Stock Repair Strategy is an options trading strategy designed to "repair" a stock account that has suffered from capital loss due to a drop in price. The Stock Repair Strategy allows the loss to be recovered with just a moderate rise in the price of that stock. For example, if you bought shares of XYZ company and it has dropped significantly (10% for example) since you bought it, you could use the Stock Repair Strategy to recover that 10% loss as long as XYZ company stock rises about 5%. This is achieved through the buying of call options on that stock, funded by the writing of twice the amount of out of the money call options. Hence, the Stock Repair Strategy does not cost anything to put on (apart from brokerage fees of course) and requires no margin. This makes the Stock Repair Strategy an ideal strategy for anyone who wish to quickly recover losses sustained in a stock position.
When Should You Use The Stock Repair Strategy?
Use the Stock Repair Strategy to recover losses in your stock when that stock is expected to rise slightly or moderately.
How To Use The Stock Repair Strategy?
The Stock Repair Strategy simply involves buying the same amount of at the money (ATM) call options as the shares that you own and then writing twice the amount of out of the money (OTM) call options.
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Stock Repair Strategy Example
Assuming you bought 100 shares of XYZ company shares at $70 and it fell 14% to $60, losing $1000 in total value. You wish to quickly recover that lost 14% using the Stock Repair Strategy. You then sell to open 2 contracts (representing 200 shares) of XYZ $70 strike call options which are valued at $5.00. ($5.00 x 200) - ($10.00 x 100) = $0 |
The nearest Out of the money options typically cost half the price of the at the money options. As such, selling twice the amount of out of the money options covers the cost of buying the at the money options so the stock repair strategy costs nothing to put on at all. Since the extra out of the money options sold beyond the amount of call options bought are secured by the stocks that you already own, no margin is required either.
Profit Potential Of Stock Repair Strategy
The Stock Repair Strategy reaches it's maximum profit potential when stock price is equal to or greater than the strike price of the out of the money options.
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Stock Repair Strategy Example
If Stock Rises Assuming stocks of XYZ company rises to $70 from $60 within a month. Total Profits = (rise in shares) + (rise in ATM calls - premium of ATM calls) + (Premium of OTM calls) Total Profits = ($10 x 100) + ([$10 - $10] x 100) + ($5.00 x 200) = ($1000) + (0) + ($1000) = $2000 |
From the above calculations, you would realize that by going back to $70, which was the price the XYZ shares were initially bought, the position is not only repaired but also up by $1000. In fact, the beauty of the stock repair strategy is that it allows the position to be brought back to breakeven if the stock just moved back up half of what it lost.
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Stock Repair Strategy Example
Breakeven Calculation The 2 contracts of $70 strike call options would expire while the $60 strike call options would now be worth $5.00 and the shares will now be worth $65. Total Profits = (rise in shares) + (rise in ATM calls - premium of ATM calls) + (Premium of OTM calls) Total Profits = ($5 x 100) + ([$5 - $10] x 100) + ($5.00 x 200) = ($500) + (-$500) + ($1000) = $1000 |
Using the Stock Repair Strategy, the stock needs only move up by $5 to reach breakeven even though the stock dropped $10!
Breakeven Point of Stock Repair Strategy
The Stock Repair Strategy costs nothing to put on and if the stock drops further, the ATM calls simply expire with the OTM calls, which completely offset each other, causing no additional (additional as in no more than the loss in the stock value itself) losses to the account.
Stock Repair Strategy Greeks
The Stock Repair Strategy results in a position that is delta positive, theta positive but gamma negative. This means that the position value will increase at a decreasing rate as the stock rises until it can no longer produce any gains (beyond the strike price of the otm calls) and will also benefit from time decay as the stock options in the Stock Repair Strategy approaches expiry.
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Stock Repair Strategy Example
Options Greeks Assuming you bought 100 shares of XYZ company shares at $70 and it fell 14% to $60, losing $1000 in total value. You wish to quickly recover that lost 14% using the Stock Repair Strategy. You buy to open 1 contracts of XYZ $60 strike call options valued at $10.00. You then sell to open 2 contracts of XYZ $70 strike call options which are valued at $5.00. The cost of the trade is: ($5.00 x 200) - ($10.00 x 100) = $0 Position Delta = [(delta of shares) + (delta of atm calls)] - (delta of otm calls) = [(100) + (0.5 x 100)] - (0.4 x 200) = (100 + 50) - 80 = 70 Position Theta = (theta of otm calls) - (theta of atm calls) = (0.022 x 200) - (0.026 x 100) = 1.8 Position Gamma = (Gamma of atm calls) - (Gamma of otm calls) = (0.055 x 100) - (0.054 x 200) = - 5.3 |
In the above Stock Repair Strategy greeks example, the position is expected to rise by $70 with every dollar XYZ stocks rise and makes $1.80 a day due to time decay. Bear in mind that this is only a snap shot of the expected performance of the Stock Repair Position when it is first put on. The real potential of the Stock Repair Strategy is unleashed only when it is held until expiry.
Advantages Of Stock Repair Strategy
1. Able to bring a stock account back up to breakeven as long as stock rises moderately.
2. Costs nothing to put on.
3. Requires no margin.
Disadvantages of Stock Repair Strategy
1. No further profits can be obtained if the stock rallies beyond the strike price of the OTM calls.
Stock Repair Strategy Questions
:: How Can I Repair A Losing Stock With Options?
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