The stock repair strategy is ideal for an investor holding a stock position on which he has an unrealized loss and would be satisfied to simply break even. It helps the investor by reducing his stock position's break-even point for little or no out-of-pocket cost. The strategy does not protect the existing stock position from further downside loss, but doesn't increase risk on the downside either. In return, the investor generally gives up any upside potential beyond the new reduced break-even point.
Determining Strike Prices
One consideration when establishing the repair strategy is which option should be purchased, and which should be sold. Note that in our example the unrealized loss on the stock was $10 dollars and the strike price interval between the options chosen was $5, half the unrealized loss. If an investor was holding a stock now trading at $90 with an original cost of $110 (i.e., a $20 unrealized loss), he should look to purchase the $90 calls and sell the $100 calls - a $10 spread in strike prices. If an investor purchases at-the-money options, then he should consider selling out-of-the-money options that are approximately at the halfway mark between the current stock price and the original acquisition cost.
Can the Repair Strategy be implemented for all stocks that are trading below the purchase price? Unfortunately not. The strategy will generally work for stocks that are down 20% from their entry point (using options that may have 60 to 90 days to expiration), but will prove inadequate for stocks down 40% or 50%. In the latter cases, investors will find that selling two out-of-the-money calls will not generate enough premium to finance the one at-the-money call purchased.
Finally, very often, the strategy can be initiated for a small credit or a small debit. An investor might still consider the strategy in those cases were he may have to pay $0.25 or $0.50 for initiating the option position. In these cases the investor may give up this small debit no matter how high the stock increases in price. However, he might find that the overall benefits of the strategy are worth a minimal outlay. On the other hand, if the option position is established for a small credit, above the reduced break-even point he might keep this credit. Final profit & loss scenarios from using the repair strategy will vary depending on the original stock purchase price, the stock's price when establishing the repair, the strike prices chosen and whether the option position is established at no cost or for a small debit or credit.
Stock Repair Worksheet
Download the "Who Should Consider Using the Stock Repair Strategy?" Worksheet