Repair & Exit Strategies
Presented by The Options Industry Council
1-888-OPTIONS
www.888options.com
Repair & Exit Strategies
Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained by contacting your broker or The Options Industry Council at One North Wacker Drive, Chicago, IL 60606. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
Presentation Outline
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
Repair & Exit Strategies
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
Repair & Exit Strategies
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 dont have to just hold & hope
Repair & Exit Strategies
Stock Repair Strategy
Stock Repair Strategy
Buy 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 Strategy
Buy 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 stock purchase) trade-off upside profit potential capped
Stock Repair Strategy
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
Stock Repair Strategy
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 = 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 Example
At 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 Example
At Expiration
XYZ at $65 $500 loss on stock = $500 profit on options new breakeven point (vs. $70 for stock purchase) XYZ above $65 profit/loss on stock = profit/loss on options
Not including commissions
At Expiration
Long 100 XYZ @ $70
XYZ Profit (Loss) Stock
Long 1 XYZ 60 call @ $3.50 Short 2 XYZ 65 calls @ $1.75
Profit (Loss) 1 XYZ 60 call Profit (Loss) 2 XYZ 65 calls Net Profit (Loss)
50 55 60 62 65 70 75 80
(2,000) (1,500) (1,000) (800) (500) 0 500 1000
(350) (350) (350) (150) 150 650 1,150 1,650
350 350 350 350 350 (650) (1,650) (2,650)
(2,000) (1,500) (1,000) (600) 0 0 0 0
Not including commissions
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 Stock Position & 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 Position
Collar
Long Stock
Limited Profit Collar
Limited Loss
2 Commissions: 1 for Call & 1 for Put
Covered Call
Stock 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 Call
Stock 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 & call expires 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 Put
Option 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 Calls
Price 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 Put
Option 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 Put
Option 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 Call
Option 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 Put
Assignment 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 Put
Assignment Risk at Expiration
Managing pin risk
assignment acceptable do nothing assignment not acceptable consider closing short at minimal cost as market closes last trading day be vigilant as expiration nears dont 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 Dont be afraid to admit you are wrong and cut losses No one exit strategy is the best investigate and be open to many possibilities No buying power in your account can reduce flexibility on exit
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