"How Can I Repair A Losing Stock With Options?"

Question By Travis

"How Can I Repair A Losing Stock With Options?"

How can I use options to turn a profit on a stock I currently own that has a decreasing share price?

Asked on 19 Aug 2010

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Answered by Mr. OppiE

Hi Travis,

Options are indeed the most versatile financial instrument you can use for hedging your stocks and there are indeed a few ways you could use options to salvage a losing stock position. I will introduce three of the more common methods here which you can execute without any margin requirement.

If you are of the opinion that the stock may start to come back up but you still want some protection should it continue to fall, you could use what is known as a "Protective Put" strategy in order to stop your position from making further losses. The Protective Put strategy simply involves buying a 1 contract of put options for every 100 shares you own at a strike price you don't want the stock to go further than. The Protective Put options strategy not only protects your stocks from going down further, it keeps the upside open so that if the stock turns around and rally strongly, you won't miss out on the move. Its like buying insurance for your stocks. Read more about the Protective Put.

If you are of the opinion that the stock is going to continue going down with very little chance of coming up yet and you still somehow wants to hold on to it, you could use a Covered Call Collar options strategy. The Covered Call Collar strategy is similar to the protective put options strategy in that you also buy put options as protection. The only difference is that you will now finance the purchase of those put options with the proceeds from writing an equal number of out of the money call options. The position will still protect you from all losses below the strike price of the put options at no cost to yourself but it will stop the position from profiting beyond the strike price of the short call options should the stock stage a rally. That's right you would miss out on a strong rally in exchange for putting on the protection of the put options for free (apart from commissions of course). Read more about the Covered Call Collar.

If you are of the opinion that the stock has bottomed and is now ready to rally and you want to recuperate your losses double quick time, you could use what is known as the Stock Repair Strategy. The Stock Repair Strategy involves buying 1 contract of at the money call options for every 100 shares you own and then writing twice as much call options at a strike price which total proceeds cover (or nearly cover) the amount spent on the at the money call options. Yes, another free position apart from commissions. Having this position in place allows you to make double the profit at no extra cost if the stock rallies all the way to the strike price of the short call options and is an excellent way to quickly recuperate stock losses. Read more about the Stock Repair Strategy.

In conclusion, options are fantastic financial instruments for hedging stock positions and there will always be a specific options trading strategy you can use depending on your specific outlook on the movement of the underlying stock.

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