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Options Trading: When Your Stock's Broken, Don't Despair When You Can Repair!
With this options trading strategy, you can recoup losses when a stock goes against you.
Steve Smith    

In general, I don't like throwing good money after bad by adding to a losing position.

We can talk often ourselves into doing so by using phrases like "buying the dip" and "averaging down."  

But the the truth lies somewhere in between. 

For example, an individual stock position may go against you due to broader market or sector news. Or an ETF you jumped on when it hit the 20-day moving average may look even better when it drops to the 200.

If a dip is perceived to be temporary, an options-based stock repair strategy can quickly recoup losses with very little additional risk.  

Some recent situations might include this morning's sell-off in CVS (NYSE:CVS) after competitor Walgreen (NYSE:WAG) took hit for cancelling plans for a tax inversion. 

CVS tumbled some 4% on the opening even though its operations have zero to do with what's going on with Walgreen's deal activities. 

Or take Michael Kors (NYSE:KORS) and Buffalo Wild Wings (NASDAQ:BWLD) which both dropped sharply following earnings despite the fact both reports were solid.

Let's use United Parcel Service (UPS) to illustrate how a stock repair strategy works. It took a hit on earnings, but for the sake of argument, let's say we're still bullish on it.

Assume we went long 1,000 shares of UPS at $102 the day before the July 29 earnings report. With the stock trading at $96 today, we are staring at a $6,000 loss.   

The basic construction is to buy a ratio call spread for no cost or even a credit. This will provide more upside exposure, allowing us to recoup losses on a smaller move higher but not incurring additional risk.

For example, in UPS one could:

-Buy 10 October $95 calls for $2.70 a contract
-Sell 20 October $97.50 calls for $1.60 a contract

This is a $0.50 net credit per lot for a 1x2 spread. For every $2.70 spend on a $95 call, we are receiving $3.20 for selling two $97.50 calls.

In total, this would work out to $500 for a 10x20 contract position. 

The new position is can now be viewed in two parts:

1) A 1,000 share covered call position with $97.50 as the cap. (using 10 of the $97.50 calls)
2) A 10 contract $95/97.50 bull call spread.

If shares rise above $97.50, the covered call the stock will be called away at an affective sale price of $99.10. That is the strike plus the premium sold. $97.50 + $1.60 = $99.10. 

On the original 1,000 shares, this would represent a $2,900 loss. This is the difference between the purchase price of $102 per share and the effective sale price of $99.10, multiplied by 1000 shares.

The call spread will be fully in the money and worth $2.50, delivering a $1.40 profit or $1,400 for the 10 contracts.

The net result, assuming we closed out the position, would have been to reduce the total loss to just $1,600 on a move up to $97.50. 
If one had merely held the stock,  would still have a $4,500 loss at the $97.50 price level. ($102 - $97.40 X 1000 shares)

By collecting a premium for the 1x2 spread, there is no additional downside risk beyond the original 1,000 shares. In fact, the premium actually provides a small amount of downside protection.

Note that the numbers become more attractive for stocks whose options have high implied volatility readings. This allows for greater credits or higher strike prices that allow more money to be recouped, or even a profit to be realized, if shares bounce back.

So the next time one of your stocks sinks, don't despair when you can repair.

To learn moure about Steve Smith's options trading philosophy, check out our 9 Weeks to Better Options Trading series.

Twitter: @steve13smith

For more from Steve Smith, take a FREE 14-day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.
 

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No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Options Trading: When Your Stock's Broken, Don't Despair When You Can Repair!
With this options trading strategy, you can recoup losses when a stock goes against you.
Steve Smith    

In general, I don't like throwing good money after bad by adding to a losing position.

We can talk often ourselves into doing so by using phrases like "buying the dip" and "averaging down."  

But the the truth lies somewhere in between. 

For example, an individual stock position may go against you due to broader market or sector news. Or an ETF you jumped on when it hit the 20-day moving average may look even better when it drops to the 200.

If a dip is perceived to be temporary, an options-based stock repair strategy can quickly recoup losses with very little additional risk.  

Some recent situations might include this morning's sell-off in CVS (NYSE:CVS) after competitor Walgreen (NYSE:WAG) took hit for cancelling plans for a tax inversion. 

CVS tumbled some 4% on the opening even though its operations have zero to do with what's going on with Walgreen's deal activities. 

Or take Michael Kors (NYSE:KORS) and Buffalo Wild Wings (NASDAQ:BWLD) which both dropped sharply following earnings despite the fact both reports were solid.

Let's use United Parcel Service (UPS) to illustrate how a stock repair strategy works. It took a hit on earnings, but for the sake of argument, let's say we're still bullish on it.

Assume we went long 1,000 shares of UPS at $102 the day before the July 29 earnings report. With the stock trading at $96 today, we are staring at a $6,000 loss.   

The basic construction is to buy a ratio call spread for no cost or even a credit. This will provide more upside exposure, allowing us to recoup losses on a smaller move higher but not incurring additional risk.

For example, in UPS one could:

-Buy 10 October $95 calls for $2.70 a contract
-Sell 20 October $97.50 calls for $1.60 a contract

This is a $0.50 net credit per lot for a 1x2 spread. For every $2.70 spend on a $95 call, we are receiving $3.20 for selling two $97.50 calls.

In total, this would work out to $500 for a 10x20 contract position. 

The new position is can now be viewed in two parts:

1) A 1,000 share covered call position with $97.50 as the cap. (using 10 of the $97.50 calls)
2) A 10 contract $95/97.50 bull call spread.

If shares rise above $97.50, the covered call the stock will be called away at an affective sale price of $99.10. That is the strike plus the premium sold. $97.50 + $1.60 = $99.10. 

On the original 1,000 shares, this would represent a $2,900 loss. This is the difference between the purchase price of $102 per share and the effective sale price of $99.10, multiplied by 1000 shares.

The call spread will be fully in the money and worth $2.50, delivering a $1.40 profit or $1,400 for the 10 contracts.

The net result, assuming we closed out the position, would have been to reduce the total loss to just $1,600 on a move up to $97.50. 
If one had merely held the stock,  would still have a $4,500 loss at the $97.50 price level. ($102 - $97.40 X 1000 shares)

By collecting a premium for the 1x2 spread, there is no additional downside risk beyond the original 1,000 shares. In fact, the premium actually provides a small amount of downside protection.

Note that the numbers become more attractive for stocks whose options have high implied volatility readings. This allows for greater credits or higher strike prices that allow more money to be recouped, or even a profit to be realized, if shares bounce back.

So the next time one of your stocks sinks, don't despair when you can repair.

To learn moure about Steve Smith's options trading philosophy, check out our 9 Weeks to Better Options Trading series.

Twitter: @steve13smith

For more from Steve Smith, take a FREE 14-day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.
 

< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Daily Recap
Options Trading: When Your Stock's Broken, Don't Despair When You Can Repair!
With this options trading strategy, you can recoup losses when a stock goes against you.
Steve Smith    

In general, I don't like throwing good money after bad by adding to a losing position.

We can talk often ourselves into doing so by using phrases like "buying the dip" and "averaging down."  

But the the truth lies somewhere in between. 

For example, an individual stock position may go against you due to broader market or sector news. Or an ETF you jumped on when it hit the 20-day moving average may look even better when it drops to the 200.

If a dip is perceived to be temporary, an options-based stock repair strategy can quickly recoup losses with very little additional risk.  

Some recent situations might include this morning's sell-off in CVS (NYSE:CVS) after competitor Walgreen (NYSE:WAG) took hit for cancelling plans for a tax inversion. 

CVS tumbled some 4% on the opening even though its operations have zero to do with what's going on with Walgreen's deal activities. 

Or take Michael Kors (NYSE:KORS) and Buffalo Wild Wings (NASDAQ:BWLD) which both dropped sharply following earnings despite the fact both reports were solid.

Let's use United Parcel Service (UPS) to illustrate how a stock repair strategy works. It took a hit on earnings, but for the sake of argument, let's say we're still bullish on it.

Assume we went long 1,000 shares of UPS at $102 the day before the July 29 earnings report. With the stock trading at $96 today, we are staring at a $6,000 loss.   

The basic construction is to buy a ratio call spread for no cost or even a credit. This will provide more upside exposure, allowing us to recoup losses on a smaller move higher but not incurring additional risk.

For example, in UPS one could:

-Buy 10 October $95 calls for $2.70 a contract
-Sell 20 October $97.50 calls for $1.60 a contract

This is a $0.50 net credit per lot for a 1x2 spread. For every $2.70 spend on a $95 call, we are receiving $3.20 for selling two $97.50 calls.

In total, this would work out to $500 for a 10x20 contract position. 

The new position is can now be viewed in two parts:

1) A 1,000 share covered call position with $97.50 as the cap. (using 10 of the $97.50 calls)
2) A 10 contract $95/97.50 bull call spread.

If shares rise above $97.50, the covered call the stock will be called away at an affective sale price of $99.10. That is the strike plus the premium sold. $97.50 + $1.60 = $99.10. 

On the original 1,000 shares, this would represent a $2,900 loss. This is the difference between the purchase price of $102 per share and the effective sale price of $99.10, multiplied by 1000 shares.

The call spread will be fully in the money and worth $2.50, delivering a $1.40 profit or $1,400 for the 10 contracts.

The net result, assuming we closed out the position, would have been to reduce the total loss to just $1,600 on a move up to $97.50. 
If one had merely held the stock,  would still have a $4,500 loss at the $97.50 price level. ($102 - $97.40 X 1000 shares)

By collecting a premium for the 1x2 spread, there is no additional downside risk beyond the original 1,000 shares. In fact, the premium actually provides a small amount of downside protection.

Note that the numbers become more attractive for stocks whose options have high implied volatility readings. This allows for greater credits or higher strike prices that allow more money to be recouped, or even a profit to be realized, if shares bounce back.

So the next time one of your stocks sinks, don't despair when you can repair.

To learn moure about Steve Smith's options trading philosophy, check out our 9 Weeks to Better Options Trading series.

Twitter: @steve13smith

For more from Steve Smith, take a FREE 14-day trial to OptionSmith and get his specific options trades emailed to you along with exclusive access to his full portfolio. Learn more.
 

< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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