For example, if an investor purchased 400 shares of BBB at $40 and this stock is now trading at $30, buying an additional 400 shares at $30 reduces the average cost of the 800 shares to $35. If BBB rallies back to $35, all the shares can be sold to break even.
But there are 2 problems with doubling up to catch up. First, it requires an additional investment, $12,000 in our example. And second, by doubling the number of shares, the downside risk also doubles: with an 800-share position, every dollar drop in BBB now generates losses of $800 versus $400 before the position was increased.
How can one capture the benefit of doubling up (lowering the break even point), without its drawbacks (additional funds required, increased risk)?
Here is a possible strategy: first, purchase 4 of the November 30 calls at $3.00. These options give us the right to purchase an additional 400 shares, but only if it will be to our advantage. We have not doubled up, we have obtained the right to double up.
Second, write 8 of the November 35 calls at $1.50. This represents the obligation to sell 800 shares of BBB at 35, the 400 shares that we currently own, and the 400 shares that we have the right to purchase at 30 by exercising our long 30 calls. Note that both legs of this strategy, the purchase of the 30 calls, and the writing of the 35 calls, can usually be done as one spread trade.