Stock options have a myriad of applications. With our covered call writing and put-selling strategies, we seek to generate cash-flow in a low-risk manner. Another utilization of stock options is to mitigate losses when share price declines. This is known as the stock repair strategy. It is used when a stock is purchased ( with no option component) and share price declines significantly. Options can be leveraged to mitigate.
What is the Stock Repair Strategy?
When shares are owned at a higher price than current market value, the breakeven price point is lowered by purchasing 1 near-the-money call option and funding that purchase by selling 2 out-of-the-money call options with strikes between current market value and original purchase price. This also known as a 1 x 2 ratio call spread.
Advantages of the stock repair strategy
The breakeven is lowered without adding any significant amount of cash to the trade. There may be a small option debit but there also can be a small option credit. This can replace averaging down where additional shares are purchased at a lower price to lower the breakeven. With the latter approach, additional cash is added to an already losing trade.
Disadvantages of the stock repair strategy
We must be willing to forego potential profit in exchange for lowering the breakeven price point. The trade does not protect us from continuing share price decline.
Real-life example with LYFT (price decline from $64.16 to $52.61 in 1 month)
LYFT Price Chart April – May 2021
Stock repair strategy for LYFT to lower the current breakeven of $64.16
- 1 x $52.50 near-the-money call option is purchased for $3.75
- 2 x $57.50 out-of-the-money call options (both covered) are sold for $1.75
- the 1 x 2 ratio call spread results in a net debit of $0.25
- The breakeven is lowered from $64.16 to $58.46 by adding only $0.25 per-share
- Since we are dealing with stock options, we must use the strategy in 100 share increments
The BCI Stock Repair Calculator
LYFT Stock Repair Calculations
Final trade results are calculated by adding closing trade results in the 2 white cells at the top of the spreadsheet (currently blank) and checking results in the green cells at the bottom of the spreadsheet.
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.
***For more information on the BCI Stock Repair Calculator click here.
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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:
Upcoming event
Wealth365 Summit: Free webinar
Monday October 11th at 4 PM ET
Stock Options: How to Use Implied Volatility to Determine Strike Selection
Creating 84% probability successful trades
This presentation will detail how to use implied volatility stats, standard deviation bell curves and conversion formulas to establish projected high and low ranges for price movement of a security over the life of an option contract.
These formulas will allow us to create 84% probability of success trades where share price is highly unlikely to fall below the breakeven price point or above the out-of-the-money call strike where share retention is a critical aspect of our strategy.
While there is inherent risk in all strategies that seek to beat risk-free returns (Treasuries, for example), the strategies discussed in this webinar will be ultra low-risk and appropriate for most retail investors.
Registration link to follow
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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.
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Hi Alan!
A question about the calculator. On the videos you say “the stock is trading at $x price! When I enter the numbers on the calculator on the simple tab I use the price I paid not the current price correct?
I cannot express how much I appreciate all the help you’re giving me! I am loving to trade call options!
Best Regards,
Denise
Denise,
Use the price of the stock at the time the option trade is initiated. Let’s say we bought a stock years ago and paid $50.00. Today, years later, it is trading at $103.00 and we are selling the 1-month $105.00 call at $3.00. Our basis is $103.00, leaving the initial time-value return at 2.9% ($3.00/$103.00).
If we used the price we paid originally, it would reflect a return of 6% ($3.00/$50.00).
The fact is that, at the time of the trade, we had $103.00 per-share worth of stock and that is what we are risking.
Final trade results, when shares are sold, is a different story but the BCI Calculators are used to assist us in making the best trade decisions at the time of the trades.
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 09/17/21.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
http://www.youtube.com/user/BlueCollarInvestor
On the front page of the Weekly Stock Report, we now display the Top Performing ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.
Please make sure that you review the new feature that we’ve added…Implied Volatility or IV. This is the At The Money (ATM) Implied Volatility for all of the stocks in the report.
Best,
Barry and The Blue Collar Investor Team
Alan,
I have used your stock repair calculator with excellent results. I also use 10% trailing stop loss orders something I learned from you book Stock Investing For Students.
Thanks for all the work you and your team does for us retail investors.
Marsha
Marsha,
Thank you for your generous feedback.
Alan
Hello Alan,
In your recent video on the low risk, QQQ covered calls, you mentioned there was a way to fill a trade called, “Show and fill.”
I never heard of that.
Could you please explain?
Thanks,
Wayne
Wayne,
The “Sow or Fill Rule” is an SEC regulation that requires brokers to either execute a limit order or publish it if the limit order “improves the market” It is a way to enter trades and will not appear as a dropdown on our broker trading platforms.
This means that if we place a limit order to sell an option (also works for buying) between the “bid” and “ask” published prices, the market-maker must either execute that trade or publish it and decrease the published bid-ask spread.
Here is a link to an article I published with details:
https://www.thebluecollarinvestor.com/negotiating-the-best-prices-when-buying-and-selling-options/
Alan
Alan:
This is in reference to above real time example.
Please advise what was the DTE for all the legs.
Regards.
Dilip
Dilip,
The trade entry date for all calls was 5/5/2021. The expiration date for all the call contracts was 6/19/2021, leaving the days-to-expiration at 45 when the trades were executed.
This stat will automatically appear in the spreadsheet on the top green row.
Alan
Alan,
after reading your article, I decided to place a stock repair on my 100 NVDA shares today.
Initially bought on 09/07/21 at 226.31
simultaneously sold 1 NVDA 10/01/2021 230.00 C for 6.09
bought back 09/20/21 for 0.95
BEP was 221.17
Repair:
Bought 1 NVDA 10/15/2021 210.00 C (NTM) at 8.87
Sold 2 NVDA 10/15/2021 220.00 C for 4.50
Net credit 0.13 cents
NVDA has ER expected on 11/17/21.
The market today is taking back almost all my gains from the last options cycle because I remained 50% invested today, but I hope it will return after the China property scare has calmed down.
Thank you for your timely article.
Roni
Roni,
Yes, today was about concern’s regarding China’s economy but Wednesday will be all about the FOMC statement… stay tuned.
Alan
Hi Alan,
Sound very interesting……BUT……. I don’t get it.
The cost basis is reduced by $5.70
Where are you getting that from??
I see the additional cost of $25.
A little more explanation would be greatly appreciated.
Thanks for all you do.
Ron
Ron,
Glad to explain.
The option debit in this example is $25.00 per-contract while the breakeven is lowered by $5.70 per-share or $570.00 per-contract. From that perspective, we must compare apples-to-apples.
To understand how we are lowering the breakeven by $5.70 per-share, let’s break the trade down into 2 phases:
Phase I: When we purchase the $52.50 near-the-money strike, we still don’t own additional shares but we do have the ability to exercise that option and purchase at that strike. In effect we are “averaging-down” … 100 shares at $64.16 and 100 shares at $52.50. Factoring in the $0.25 option debit (sometimes there’s an option credit, but always near zero), the new breakeven is $58.46 or $5.70 lower than the original purchase price of $64.16.
Phase II: The sale of the 2 out-of-the-money call options ($57.50 strike) is used to fund the purchase of the $52.50 call option. The calculator factors in all the debits and credits to calculate the new breakeven price point.
Alan
Hi Alan,
Thanks for the quick response.
OK…..I think I get it……But the “averaging-down” at this point is only hypothetical since you don’t own the shares.
So…..Come option expiration day and if the stock is still trading around $52.50, your breakeven is now $64.41
(64.16 + .25 since all the options expired worthless and your cost to put this on was .25)
I think the only way you actually reduce your cost basis is if you can close the ratio for something above the .25 cost. For example if the stock moves up to $57, the calls you sold would expire worthless and the $52.50 call would now be worth $4,
thus reducing your breakeven to $60.41
Is that correct? or Am I still missing something?
Ron
Ron,
You are correct in that if share price closes below the breakeven, there is a loss. It is also true that if share price closes below the (recently purchased) near-the-money strike, the ratio spread will have no impact on the trade outcome. Have a look at the “Disadvantages” paragraph of this article.
Now, the $0.25 per-share net option debit could have very well been a credit or a breakeven… it will vary from trade-to-trade but always be near zero. The purpose of selling the 2 short calls is to fund that NTM strike.
You are also correct that if share price closes below the $52.50 strike, all options expire worthless and the breakeven is $64.41 for 100 shares. However, had we averaged down by purchasing an additional 100 shares, the breakeven would, in realty, be lower but for 200 shares.
The BCI Stock Repair Calculator will do final calculations for us. Let’s use the $57.00 figure you alluded to and view the results in the screenshot below:
Without the 1 x 2 ratio spread, the loss would be $7.16 per-share. With the leverage of the options, the loss is reduced to $2.91 per-share.
There is no one strategy that is perfect is every respect. All have their pros and cons and I share all that information with our members. This way, we can all make informed decisions as to whether a particular strategy can be an asset to our portfolio and investment results.
Excellent questions.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Thank you once again Alan.
Everything you share is top notch.
Ron
Alan,
thank you for reminding me about the FOMC statement. I will not place any new trades until we see the market reaction.
Meanwhile, I have placed another repair strategy on my 100 ROKU shares which were leftover from the last cycle.
Your article continues to help me to try to mitigate my paper losses and possibly turn a losing trade into a winning trade.
Roni
Market volatility:
For years, I have been writing about the inverse relationship between the CBOE Volatility Index (VIX) and the S&P 500. This past month has been a great example of that pattern as shown in the screenshot below.
The VIX has been up by 37.67% while the S&P 500 down by 2.52%.
For most of us, a calmer market is preferred and perhaps the Fed announcement on Wednesday will provide that relief… maybe.
Every cloud does have a silver lining and the increased volatility will often create exit strategy opportunities. This morning when the market spiked up, I was able to roll-up several of my 10-Delta put options to higher strikes while still retaining that 10-Delta requirement.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Premium members:
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Alan and the BCI team
Hello Mr. Ellman,
It has been awhile since we last communicated. I bought the Blue Collar Investor book about 3 years ago. It was great. It really help me gain a better understanding of investing in Option Calls. And I still use my Ellman calculator. Perhaps another read soon.
I have a few questions (just in general) about the approach you recommend.
[1] Would you say your approach is to look for low volatility, highly stable stocks/etfs to invest in for covered call writing?
[2] What are the risks of investing in more highly volatile stocks/etfs and their options?
George
George,
1. Our stock screening is based on fundamental, technical and common-sense (minimum trading volume etc.) analysis, not on volatility. Once we have a watch list of elite-performers from those perspectives, we can select securities with volatilities that align with our strategy return goals and personal risk-tolerance.
2. High volatility stocks and ETFs will return higher premiums but also create more risk to the downside. I select an initial time-value return goal range (2% – 4% for monthly contracts) that will then align with my personal risk-tolerance and this will automatically keep me safe from securities with volatilities too high for my comfort level. The appropriate volatility will vary from investor-to-investor.
Alan
Premium members,
The High Dividend Yield Report for the 4th Quarter 2021 has been uploaded to your member site (left side).
Alan & the BCI team