Repair & Exit Strategies

Presented by The Options Industry Council

1-888-OPTIONS

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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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