Don't despair over losing stocks! This course teaches you powerful options strategies to recover losses and improve your position, even when your initial investment thesis is wrong. Learn to leverage calls and puts to reduce your break-even price and potentially profit in any market.

Scenario: An investor purchased 500 shares of GXG a few months ago at $51. The stock has since retreated to $47, a fall of 7.8%.

Looking at the options' prices, our investor quickly realizes that writing the 55 calls makes little sense: with 500 shares, writing the 64-day 55 calls would only generate $50 before transaction costs. By writing 5 of the 50 calls, either the two-month options at $0.85 (total premium of $420 before commissions) or the three-month options at $1.45 ($725 before fees) our investor can look to break-even (or very close!) on a bounce back to the $50 area. The choice between the two and the three-month option should be made in light of how quickly GXG is expected to go back to $50 and the investor's risk tolerance. He may be more comfortable pocketing $1.45 immediately and living with his position for the next three months, or he may prefer to write the two-month options at $0.85 with the thought that if GXG has not reached $50 in 36 days he might have the opportunity to write a different series of calls and pocket additional option premium.

Some investors hesitate to write covered calls in a situation such as the one described here because they feel they are getting "locked into" their stock position until the options' expiration date – don’t forget that you can always buy yourself out of the contract.

Finally it must be noted that writing covered calls against a stock that is down 5 to 10% from its purchase price will only help the investor break-even if the stock cooperates and rallies to or beyond the short calls' strike price. If, as in our example, an investor writes the two-month calls at $0.85 and GXG continues to decline the $0.85 premium received may appear as a small consolation if another $5 or $10 in losses accrue on the long stock position.

Scenario: An investor purchased 400 shares of LXL at $75 sometime ago. The stock is now trading at $65, 13% below the investor's cost. This investor would now be more than happy to simply break-even on this equity position.

The problem is that by writing the 56-day 70 calls at $2.30, for example, the investor will not break-even if the stock rallies to the calls' strike price of $70 since his cost is $75 and his effective selling price would be $72.30 (the 70 options' strike price plus the $2.30 premium). An alternative to doubling up or writing covered calls is to use options to reduce the investor's break-even point.

The repair strategy consists of the following:

Let us look at the cost and benefits of this strategy.

The cost of initiating the above strategy is the $4.20 paid to purchase 4 of the 65 calls ($4.20 times 400 = $1,680) less the premium received from the sale of 8 of the 70 calls at $2.30 ($2.30 times 800 = $1,840). This turns out to be a credit of $160, some of which can be used to pay for the transaction costs. To keep things simple in the following discussion, we will assume the options' position was initiated for even money.

By purchasing 4 of the 65 calls, he now has the right to buy an additional 400 shares at $65. Instead of "doubling up", our investor has obtained the right to double his stock position for the next 56 days. Obviously, he will only do so, (i.e., double up by exercising his long calls) if it is to his advantage. By writing 8 of the 70 calls, this investor has obligated himself to sell 800 shares at $70. But this investor does not own 800 shares, only 400. Is he writing uncovered options? No. He may only own 400 shares, but he has just acquired the right to purchase 400 additional shares. In fact, he has obligated himself to deliver the 400 shares he owns, plus the 400 shares that he has the right to purchase, all at $70. Where does this leave him on a profit and loss basis?

What if, as forecasted, the stock rallies part way back to its purchase price? The following table dissects the profits and losses for LXL prices from $65 to $70.

The accrued losses on LXL are based on a $75 cost basis. There are two columns showing the value of the short 70 calls since 2 of these were written for every 100 shares held (8 calls sold, 400 shares held). Also, we have not taken into account the cost of entering into the options position since this was done for even money. Where does this leave our investor?

The good news is that the option strategy has reduced the investor's break-even point from $75 to $70. What if LXL, at option expiration, has risen past $70? The following table will help answer this question.

As discussed above, at $70, the $5 loss on the stock is offset by the value of the 65 call and the investor breaks-even. At $71, the accrued loss on the stock is now only $4 and the net value of the 3 options is $4, once again fully offsetting the stock's accrued loss. For any of the ending stock prices in our table, the accrued losses on the stock are fully offset by the value of the option position. Another way to look at this, is that if LXL rallies above $70 our investor can do no better than breaking even. Not surprising since when he initiated the options position he obtained the right to "double up" at $65 but also assumed the obligation of selling a total of 800 shares at $70, effectively eliminating his position if LXL rallied to this $70 level.

To summarize, the repair strategy can often be initiated for even money, so at no initial cost, does not add any downside risk, although the risk of the existing stock position is not diminished or eliminated; it also reduces the break-even, but an investor can do no better than breaking even.

Entering into the repair strategy is relatively straightforward and can be done with one contingent order. But there is more than one way to existing at or close to expiration and investors need to decide which tack to take.

Assume for example that an investor was long 400 of LXL, bought 4 of the 65 calls and wrote 8 of the 70 calls. The stock price has rebounded to the $71-72 range and option expiration is just around the corner. Our investor has achieved her goal of lowering her break-even point and simply wants to exit the entire stock and option position. What are her choices?

Wait until expiry Friday, if shares still above $70, Interactive Brokers will automatically assign another 400 shares at $65 and then sell 800 shares at $70. There are no commission costs for this.

You can liquidate the call long options and half her short options, and wait for assignment on the second half of your short options. This would consist of selling 4 65 calls and buying 4 of the 70 calls, a spread that theoretically should be worth $5. But in real life you will probably not be able to obtain the full $5 on a spread order, maybe having to settle for $4.80 or $4.90. This would leave you short the remaining 4 * 70 calls which will be assigned and against which you will deliver the 400 shares of LXL. You would have to pay commissions on exiting the 4 by 4 option spread and upon assignment of the last 4 call options.

So which is the best way to exit? We look at "best" as that which will yield the most cash after transaction costs and bid-ask differentials. The first exit route has the advantage that stock will be purchased at exactly $65 and sold at exactly $70 yielding the full $5 spread.

Important Note: If the stock continues its downtrend, the options position will neither protect him against further losses nor increase his downside risk. The investor will see losses continuing to accrue on the 400 shares he still owns, but the options position will become worthless as both series of call options will be out-of-the-money and will expire worthless. The options will neither have helped or hindered as the total initial cost was nil, and their final value also zero.

CLICK HERE to take the quiz.

At this stage it is best if you start practicing for real so this is what we want you to do:

CLICK HERE to leave a review of this course on Google. We would love to get your feedback. Thank you.

Ready to take your trading to the next level? Our Pro Mentoring plan gives you the expert guidance and exclusive tools you need to master the exciting world of options and futures. Gain access to live trading sessions, personalized coaching from seasoned professionals, and a supportive community of traders. Sharpen your strategies, discover new opportunities, and unlock your full trading potential with a Share Navigator Pro trial. Don't miss out – start your journey to trading mastery today!