Repair and Exit Strategies

8/3/2019 Repair and Exit Strategies

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Repair & Exit Strategies

Presented byThe Options Industry Council

1-888-OPTIONS www.888options.com




Options involve risks and are not suitable for everyone. Prior to buying or sellingoptions, an investor must receive a copy of Characteristics and Risks of

Standardized Options . Copies may be obtained by contacting your broker orThe Options Industry Council at One North Wacker Drive, Chicago, IL 60606.

In order to simplify the computations, commissions, fees, margin interest andtaxes have not been included in the examples used in these materials. Thesecosts will impact the outcome of all stock and options transactions and must beconsidered prior to entering into any transactions. Investors should consult theirtax advisor about any potential tax consequences.

Any strategies discussed, including examples using actual securities and pricedata, are strictly for illustrative and educational purposes only and are not to beconstrued as an endorsement, recommendation, or solicitation to buy or sellsecurities. Past performance is not a guarantee of future results.



• Repair & exit strategies

• general statements & issues

• Stock repair strategy

• what it is & when to use it

• advantages & disadvantages

• Exit Strategies

• long stock position

• long call or put position• short call or put position

• short option – pin risk

•

Concluding comments

Presentation Outline




• Before you exit you must enter the market• having a plan is most important

• foresee possible outcomes

• fully understand your risk vs. reward

• understand ramifications of long vs. short options

• Discipline• what loss would be tolerable?

• what profit would be sufficient?• predetermining both will help your exit




• After position established – profits or losses

• Stock or option investor – you have choices

• realize a profit or increase unrealized profits

• protect original investment

• protect yourself from (further) losses

• Be creative & flexible – many choices available

• Exit/repair method should fit the situation• no one method always the best

• You don’t have to just hold & hope




Stock Repair Strategy



Stock Repair StrategyBuy Stock & It Declines – What to Do?

•

Do nothing (hold & hope)• must rally to purchase price to recover investment

• downside risk remains same – original investment

• Double up (buy more)• lowers upside breakeven & downside risk increased

• additional cash required

Or…



Stock Repair StrategyBuy Stock & It Declines – What to Do?

• Establish stock repair with call options• lowers breakeven on upside

• little or no additional funds required

• downside risk remains same (original stockpurchase)

• trade-off – upside profit potential capped




• What is it?

• own 100 underlying shares

• overlay ratio call spread: buy call & sell 2

• call spread – little or no net cost (credit possible)

• No uncovered calls• 1 short call covered by 100 underlying shares

• 1 short call covered by long call

• Investor wants• to recover original investment (at lower breakeven)

• no additional downside risk + no additional cash




• Generally best after modest stock decline

• Choosing strikes – rule of thumb• buy 1 at-the-money call

• sell 2 calls with higher strike

• strike increment = ½ stock loss

• Expiration month?• longer-term for no-cost spread

• more stock declined more time for possible rally

• Paying debit for ratio spread?• consider minimal cost vs. upside benefits



Stock Repair Example

• Buy 100 XYZ at $70 per share – now $60

• stock loss = $10• strike price increment = $5

• Investor wants 2 months for stock recovery

• Establish XYZ 60/65 call spread – 1 by 2• buy 1 60-day XZY 60 call at $3.50

• sell 2 60-day XYZ 65 calls at $1.75

• $3.50 paid – $3.50 (2 x $1.75) received = no cost

• Further downside loss from stock purchase

• no downside risk from options



Stock Repair ExampleAt Expiration

• XYZ at $60 or below

• options expire worthless – no profit/loss

• loss on original stock purchase

• XYZ between $60 & $65• loss on stock + gain on options = partial loss

Not including commissions



Stock Repair ExampleAt Expiration

• XYZ at $65

• $500 loss on stock = $500 profit on options

• new breakeven point (vs. $70 for stockpurchase)

• XYZ above $65

• profit/loss on stock = profit/loss on options




At Expiration

(600)350(150)(800)62

0(2,650)1,650100080

0(1,650)1,15050075

0(650)650070

0350150(500)65

(1,000)350(350)(1,000)60(1,500)350(350)(1,500)55

(2,000)350(350)(2,000)50

Net

Profit (Loss)

Profit (Loss)2 XYZ 65 calls

Profit (Loss)

1 XYZ 60 call

Profit (Loss)

StockXYZ

Long 100 XYZ @ $70 Long 1 XYZ 60 call @ $3.50Short 2 XYZ 65 calls @ $1.75




At Expiration

• Original objectives met

• downside loss limited to original stock purchase• upside stock breakeven from $70 to $65

• no additional funds required

• XYZ back to $70 or above – change of opinion?• stock profit/loss = 0 (original purchase price)

• close out spread at intrinsic value = 0

• back to where you started



At Expiration

• Things to consider with stock repair strategy

• strike prices – cost for spread and new breakeven?• expiration – how much time for stock to recover?

• option prices – do currently available make sense?



Exit Strategies

Profitable Long StockPosition

&

Covered Call



Profitable Long Stock Position

Collar

• Buy stock – price increases

• protect unrealized profits – defer profitable stock sale

• Collar

• buy out-of-the-money protective put

• sell (covered) out-of-the-money call – finances put• small debit, zero cost or net credit

• Downside

• shares protected by put

• Upside

• short call caps gains – possible early assignment



Profitable Long Stock PositionCollar

LongStock

Collar

LimitedLoss

LimitedProfit

2 Commissions: 1 for Call & 1 for Put



Covered CallStock Price Increases

• Above strike at or near expiration – do nothing

• accept assignment

• original goal met – stock sale at call strike price

• realize maximum profit

• Above strike before expiration – close position

• no longer bullish – buy back call & sell stock

• liquidate = capital available for other investment

• may be giving up call time value



Covered CallStock Price Increases

• Above strike before expiration – consider roll

• retain stock – still moderately bullish• roll up: more upside potential

• roll out: more time value & time ‘til expiration

• roll up & out: more upside & time

• Above strike before expiration – close call only• still bullish – retain stock & buy back call

• stock gain may cover cost of call repurchase• no assignment possibility



Covered Call

Stock Price Declines

• Below strike at/near expiration – do nothing

• still moderately bullish – retain stock & callexpires• no longer bullish – let call expire & sell stock• consider selling another call after expiration

• consider stock repair after expiration

• Below strike before expiration – consider roll• roll down: more premium income

• roll out: more time value & time ‘til expiration• roll down & out: more income and time



Exit Strategies

Long Call or Put Position



Long Call or PutOption Price Increases

• At or near expiration – close position• sell options – free-up cash to invest elsewhere

• Before expiration – partially close position• sell enough to recover original investment

• bought 10 @ $6 – sell 6 @ $10 = 4 “free”options

• Before expiration – consider rolling• buy options with total cash received from sale• buy options with only profits = “free” new options



Long CallsPrice Increases - Spread

• Buy call – leg into bull call vertical spread• sell call (2nd leg) with higher strike – take in premium• now limited upside profit potential• Reduced original downside risk

• Example• bought 1 XYZ 50 call @ $4.00• XYZ now at $60 – XYZ 50 call now at $10.00• sell 1 XYZ 60 call @ $1.50 – same expiration

• upside potential: (60 - 50) - ($4 - $1.50) = $6.50• downside risk reduced: $4 - $1.50 = $2.50



Long Call or PutOption Price Decreases

• Before expiration – close position

• accept outlook on underlying as incorrect• sell position – cut losses while options have

value

• Before expiration – consider rolling

• roll up/down, roll out or roll up/down and out

• Before expiration – double up• convinced outlook on underlying good until

expiration• willing to devote more cash• be comfortable with (can afford) increased risk



Exit Strategies

Short Call or Put Position



Naked Short Call or PutOption Price Increases

• Very risky positions

• Large margin requirements

• Before expiration – close position

• have a predetermined limit for loss• close out (buy back) call position at that limit

• Before expiration – leg into spread

• before damage too great – prevent disaster

• reduce damage from unfavorable move

• reduce already limited potential profit



Naked Short CallOption Price Increases

• Before expiration – leg into bear call spread

• buy call (2nd leg) with higher strike• now limited downside profit potential• reduced original upside risk

• Example• sold 1 XYZ 50 call @ $3.00• XYZ now at $55 – XYZ 50 call now $7.00• buy 1 XYZ 55 call @ $2.00 – same expiration• upside risk reduced: (55 - 50) - ($3 - $2) = $4.00• downside profit reduced: $3 - $2 = $1.00



Short Call or PutAssignment Risk at Expiration

• Short an in-the-money call or put at expiration

• assignment can be expected• auto-exercise thresholds

• Short an at-the-money call or put at expiration

• long holder may choose to exercise

• assignment possible – “pin risk”



Short Call or PutAssignment Risk at Expiration

• Managing pin risk

• assignment acceptable – do nothing

• assignment not acceptable – consider closing shortat minimal cost as market closes last trading day

• be vigilant as expiration nears – don’t be surprised



In Conclusion



Concluding Comments

• Before you jump into the market consider how you

might get out• Know in advance both your tolerance for risk and acceptable

profit

• Don’t be afraid to admit you are wrong and cut losses

• No one exit strategy is the best – investigate and beopen to many possibilities

• No buying power in your account can reduce flexibility on exit



1-888-OPTIONS

www.888options.com

Repair and Exit Strategies

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