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Stock Repair - An Option Trading Strategy

The stock repair strategy is a multi-leg strategy that helps the traders recover losses

from the long position whose price has fallen.


Traders can have very limited potential to profit from this strategy. This strategy does not determine the downside risk; this strategy's structure helps lower the break-even prices of the long stock position currently at a loss. Whatever income a trader can generate by selling the spread of the position helps in recovering from the loss from the original long stock. Traders enter the stock repair strategy without any cost or for credit.


Stock repair strategy from the markets outlook:


The traders use this stock repair strategy when they have incurred a loss on the stock

position and further wish to reduce the price increase on the stock and come closer

to the break-even point. In this strategy, the potential upside profit is limited and is

the only alternative instead of holding the position and allowing some time to repair

itself or adding the new shares and lowering the cost of the trade; this will add more

cost. If the stock repair strategy is implemented correctly, it will bring the position near

to break-even of the original trade; when it is achieved, the further downside risk is

limited.


How can I set up a Stock repair strategy?


This strategy is created when the traders combine the call ratio spread and long stock

position. To set up this strategy, traders need to buy an at-the-money call and sell

two out-of-the-money calls at a high price. Thus at-the-money long call options will

be below the cost of entering the long stock. The short options will become the new

break-even price for the original position of the trade. Suppose the stock prices have

constantly been falling since it was purchased; traders use this strategy to overcome

the risk.


The trader can open the stock repair at no cost or for small credit, and this credit will

help them to decrease the cost of the initial trade.


Understand the diagram of the Stock repair strategy:


When traders combine the potential profit or loss of owning the long stock and a call

ratio spread, the diagram of the stock repair strategy is created. The highest profit will

get limited to the strike price of the short call options, and the break-even point will be

narrowed by now.


For example: If a trader has bought 100 shares at Rs.50 each. The price of the shares

has now declined to Rs. 40. In the above scenario, a trader can take the help of a stock

repair strategy to reduce the cost of the position. To repair this decline, the trader orders one buy-to-open long call option at-the-money at Rs. 40 and two sell-to-open

orders for the short call option contract, out-of-the-money and above the long option

contract at Rs.45. Buying the long call will give a trader Rs.400 and selling two contracts will result in the credit of Rs. 200 each.


If a trader has bought the long calls for Rs.400 and sells two short calls at Rs. 200 each,

the net cost will become Rs. 0. Now, in this case, if the stock remains below Rs. 40, all

contracts will expire worthlessly.


Traders may implement the same strategy for the contracts expiring next month. Let's

say the stock closes above Rs.40 but below Rs. 45 at the time of expiry, the short calls will expire worthlessly, and traders may sell the long call options contract with their remaining intrinsic value. It will bring some additional credit reducing the break-even point of the original position. Traders may opt to close the position and enter a new one for some later expiry date.


For example : if the stock closes at Rs. 42, the stock repair strategy would have

collected Rs. 200. If traders sell the stock, it will result in a loss of Rs. –600, which is

better than incurring the Rs. -800 loss without implementing the strategy.


Now, imagine if the stock closes at a price above Rs. 45 at the time of expiry. Here the

long call option and one short call will get canceled out. The remaining short call will

sell the shares at Rs. 45. By doing so, the strategy will close at break-even and result

in gaining Rs.500, and the long calls cancel the loss of Rs. 500 on the position of the

long stock. The only disadvantage of this strategy is even if the stock closes above

Rs. 50, the position will earn equal to the break-even price.

Stock repair option trading strategy

How can I enter the stock repair?


The stock repair strategy can be said a call ratio spread in which traders buy at-the-money call options and sell two out-of-the-money call options at a high price against every hundred shares of the underlying assets they own. All three options must have the same expiry date. The traders use this strategy on the existing stock position to reduce the cost basis and increase the chance of breaking even.


In the stock repair strategy, traders buy at-the-money long call option contracts at a lower strike price than the stock's original cost. Traders sell the short options at a higher price. This price must offset the cost or at least collect more money than initially purchased. Only if the trader does this, the strategy will be helpful.


For example: a trader has bought 100 hundred shares at Rs. 50. They are currently being traded at Rs. 40. Here, the trader may enter the stock repair strategy by buy-to open(BTO) one long call option having a strike price of Rs. 40 and sell-to-open (STO) two short call options at a strike price of Rs. 45. All the options must have the same expiry dates. Suppose the trader buys a long call at Rs.400; selling the short calls will receive a credit of at least Rs.400, which will neutralize the overall position. In this way, the strategy is successful.


How can I exit from the stock repair?


Traders can exit from the stock repair strategy depending on the stock price at the time of expiry. If the price is above short calls, then all the option contracts will expire in-the-money and traders have to sell the stock at the strike price of short calls. If the stock closes between the long and short call options at the time of expiry, the short calls will expire worthlessly, and long call options will be in-the-money. Traders may sell the long call option contract and the stock together, or only the long call with the remaining intrinsic value and re-enter a new stock repair strategy with a future expiry date. If the underlying stock closes below the long call options at the time of expiry, all options contracts will expire worthlessly. If traders have received any credit throughout the duration of the strategy, that will remain, but the overall position will result in a net loss. Opening a new repair strategy with a future expiry date would be a wise choice for a trader in the above scenario.


Impact of the time decay factor on the stock repair strategy


There is a very minimal impact of the time decay or theta factor on the stock repair strategy. The short calls will be impacted positively, and the long ones negatively. Although the strategy does not gain anything profitable from the time decay factor, it has a minimal role in this strategy. The more time the strategy has to expire, the more worth options will gain, applicable to all the options contracts involved.


Impact of Implied volatility on the stock repair strategy


The implied volatility has minimal effect on the stock repair strategy. The implied volatility rate may affect the option's price while entering the strategy, but it will affect

all the options simultaneously.


How can I adjust the stock repair strategy?


The stock repair strategies are not generally adjusted. The main purpose of this strategy is to reduce the cost basis of the original position and to narrow the break-even point. In case the price of the stock is continuously falling, traders may buy the short calls and sell them at a lower price; selling the short calls will bring additional credit, but also, the traders have to sell the stock at a lower cost, and the stock is called away. If the credit received by the trader is insufficient to cover the lower strike price, the adjustments made will result in a loss to the trader.


If the traders believe that the stock will rise and do not want the stock to close at

break-even at that time, they can adjust the stock repair strategy. If the price of the

stock is rising, traders may buy or resell the short calls at a high price on a later expiry

date. Traders may exit entirely from the position and buy the new calls, but it will cost

more than the original position. So, the stock must be in a bullish scenario in order to

exceed the cost added to the position.


How can I roll the stock repair strategy?


If the underlying stock's price is above the strike price of the long call at the time of

expiry, traders may roll the stock repair strategy to extend the trade duration. Traders

may buy or sell in-the-money options and reopen them at some future expiry date,

with either the same or different strike price based on the underlying asset's price

movement.


Suppose the underlying stock's price is below the long call strike price at the time of expiry. In that case, traders may roll the stock repair strategy to extend the duration of the trade and buy some additional time to arrive at break-even on the long stock position. Traders may sell or buy in-the-money options and reopen them at some future expiry date, either with the same strike price or at a different strike price based on the underlying asset's price movement.


How to hedge the stock repair strategy?


Stock repair options strategies are not generally hedges because the main purpose

of this strategy is to reduce the break-even point. The risk associated with the downside movement is not considered in stock repair. If traders want to minimize the downside risk, they may consider another strategy.


So, this was all about the stock repair strategy in the options market. Traders do not

popularly prefer this strategy because it always results in a net loss situation. However,

if you still want to reduce the loss of your position, you may enter a stock repair strategy.


We advise you to get help from the experts if this strategy is new to you. Please get in

touch with us at the contact number below or by email for any help you require.


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