This is called the Stock Repair Strategy. Let’s say you bought 100 shares of ABC stock at $200 per share thinking the stock would go up in value. But the stocks gets hammered and drops to $100 per share. Your $20,000 investment is now worth $10,000. If you think the stock will rebound, then you can hold onto the 100 shares and hope the price eventually goes back to $200, but that could take a long time. As a matter of fact, from where you are now, the stock would have to double for you to just break even!
Here is what you can do to shorten the recovery time. With ABC stock price at $100, buy 1 contract of the At-The-Money ABC 100 Call. You select an expiration date, maybe 4 months or 6 months, or whatever time frame from your reading of the chart tells you. Once you buy the ATM Call, say 6 months out, your current position is long the 100 shares you bought originally, and you are long 100 shares on your option. Let’s say you paid $10 for 1 contract at the 100 strike price for a debit of $1,000. The next thing you do is sell 2 calls at the 150 strike price. This will bring in a credit to help pay for the $1,000 debit. Let’s say you bring in $300 in credits. So you are spending $700 to potentially recover more quickly. This $700 could be lost, but it is a relatively small amount compared to your original investment.
It is important that you are still bullish on your stock. If the stock goes down, you will lose money on the shares you own, and you will lose money on the Call you bought, but keep the money on selling the 2 out-of-the-money Calls. If the stock rebounds, as you are believing, then the road to break even will happen much faster. If the stock went up to $150 (not the $200 you bought in at), you have reached break even. How? The 100 shares you own are up $50 each and your Call option is worth $50 for each of the shares in your option contract (100 shares). So if the price of ABC goes to $150 (still a long way away from your original $200 price) you made $50 on your shares owned ($5,000) and you made $50 for 1 contract purchased ($5,000), so you are back to even, except you will still be out the $700 spent on the 100 Calls ($1,000 debit, minus the $300 in credit from the two $150 Calls sold). Bottom line is that you don’t have to wait for the stock to go from $100 to $200 per share, if it goes back to $150, you are essentially at break even.
What if the price shoots up past your Call strike price of 150, let’s say to $180 per share? This is OK, your strategy up to this point was to get back to even, and you are, you just give up the extra $30 per share because your shares would get called away, and the Call option purchased for $150 would also be maxed out not giving you the extra $30. But remember, as with all options, you can manage them along the way, by buying them back, rolling them away or out, etc.
ABC stock is just for example purposes, to show you how the math works. You may not be able to have any premium available to sell a Call at the 150 strike price, so this is just a way to show you a plan. You may have to settle for a 125 strike price, but with that you could potentially recover ½ your losses, in a much shorter time frame, and then do it again.
Benefits:
- Lowers your breakeven point from $200 to $150
- Accelerates recovery between $100 and $150
- Requires minimal additional investment ($700)
Limitations:
- Caps your potential gains above $150.
- Exposes you to additional downside risk below $100 on both your shares and the 100 Call option.
