Stock options can be used to mitigate losses on shares we own at a higher price than current market value. Some investors will buy more shares at the new lower price and average-down, thereby adding more cash to an already losing trade. This article will detail how stock options can be leveraged to lower the breakeven price point after shares of Axon Enterprise Inc. (Nasdaq: AXON) plummeted after a disappointing earnings report. This trade did not start as an option trade but call options are used in an attempt to mitigate the substantial unrealized loss at the time of the strategy implementation.
Chart of AXON showing price decline after the 5/12/2023 ER (pre- and post-earnings)
How the Stock Repair Strategy works
- Buy 1 x near-the-money call option ($200.00 long option)
- Sell 2 x out-of-the-money call options with a strike between current market value and original purchase price ($210.00 strike short calls)
- The short calls will fund the long call
- Known as a 1 x 2 ratio call spread
Calculations using the BCI Stock Repair Calculator
- The breakeven price point is reduced from $215.25 to $207.57 (blue ovals)
- Before stock repair, the loss per-share is $13.86 (green arrow)
- The pre-stock repair % stock loss is 6.44% (red arrow)
- The net option credit after stock repair is $0.12 per-share (purple arrow)
- The blank cells on the top right are used for final calculations after expiration
Final calculations: 1 scenario if share price closes between the 2 call strikes ($205.00)
Note the following (red & blue ovals):
- Per-share loss is reduced from $13.86 to $5.13
- % share loss is reduced from 6.44% to 2.38%
- The spreadsheet will calculate final results for all other scenarios
Discussion
The stock repair strategy will lower our breakeven price point by adding little or no cash to the trade. There may actually be an option credit in many cases. We must be willing to sacrifice potential upside profit and understand that we are still susceptible to further share price decline.
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Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:
Alan,
Thank you for your system. You got me started selling C/Cs (and now puts) to earn extra money in my portfolios, and it has worked very well now for several years.
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Selling Cash-Secured Puts and Strategy Choices After Exercise
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Selling Cash-Secured Puts: Multiple Applications
Selling cash-secured puts is a low-risk option strategy geared to generating cash-flow, but always with capital preservation in mind.
This presentation will detail the strategy, incorporating the 3-required skillsets necessary to achieve the highest levels of returns … stock selection, option selection and position management.
If and when we allow exercise of the put options, shares are put to us at a price we agreed upon. What is our next step? This seminar will discuss potential paths we can take and the rationale behind these decisions, using real-life examples and calculations.
Q&A will include covered call writing, cash-secured puts and related strategies.
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Thursday February 15, 2024
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Alan,
If you have a covered call trade out on a stock that is going to expire in the money, do you favor rolling out or rolling out and up? Also, assume no earnings coming up.
Thanks,
Marilyn
Marilyn,
Nice going on avoiding ERs.
There is no 1 correct answer to your inquiry.
Rolling-out is a more defensive approach to rolling options in that we almost always roll-out to an in-the-money (ITM) strike. We have the additional downside protection that the intrinsic-value component of the option offers.
Rolling-out-and-up allows us to take advantage of share appreciation, both before and possibly also after the roll. We can roll-out-and-up to an in-the-money, at-the-money (ATM) or out-of-the-money (OTM) strike.
For example, if a $50.00 call is expiring ITM as the stock price at expiration is $52.00, we can role out-and up to a $51.00 strike (ITM), a $52.00 strike (ATM) or a $55.00 strike (OTM), as examples.
Bottom line: We favor rolling-out when we want to take a more cautious approach and rolling out-and-up for more aggressive stances.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 10/13/23.
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Best,
Barry and The Blue Collar Investor Team
Premium members:
This week’s 4-page report of top-performing ETFs has been uploaded to your premium site. The Select Sector SPDR section is now crafted to align with our streamlined (CEO) approach to covered call writing. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
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Alan and the BCI team
Premium members,
The new Blue Chip (Dow 30) Report for the November contracts has been uploaded to your member site.
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Alan & the BCI team
Alan,
How much do you factor in the option greeks in your trading decisions?
Thanks,
Jeff
Jeff,
Option Greeks are critical in understanding the risk inherent in our option positions. Of the 5 Greeks, I focus in on Delta, Theta and Vega.
Now, it is not necessary to look up each of the Greeks when crafting our trades. However, it is extremely important to understand the concepts of how changes in share price (Delta), implied volatility (Vega) and time to expiration (Theta) impact our trade positions.
Once we have mastered these concepts, setting up and managing our positions will become easily managed.
Alan