What are the characteristics of this option strategy?
Stock repair is an options overlay placed on shares that have already fallen, built to lower the price at which the position gets back to even without committing more cash. The usual construction buys one call at the current, lower price and sells two calls at a higher strike in the same expiration, sized so the credit from the two short calls roughly pays for the long call. What it does not do is protect the shares. The downside stays exactly where it was, and every dollar of recovery above the short strike is given away.
Is this a bullish, bearish or neutral strategy?
Stock Repair is a moderately bullish recovery strategy: it needs a partial rebound to work, it leaves the full downside risk of the shares in place, and it caps the recovery at the short call strike. It is not a neutral or directionless trade. Without a partial rebound before expiration the calls expire worthless and the shares are still underwater.
Is this a beginner or an advanced option strategy?
The Stock Repair option strategy is considered to be a more advanced options strategy due to the need for a trader to understand the relationship between the stock and its options as well as understand implied volatility and time decay. The stock repair option strategy requires knowledge of option trading as well as the use of technical analysis in order to be successful.
In what situation will I use this strategy?
This strategy is useful when a trader wants to lower the breakeven price on a stock that has already fallen. It fits a holder who expects the shares to claw back part of the drop but not race far past the short strike, and who does not want to add money to the position. It is the wrong choice when the view is a sharp rally, because everything above the short strike is surrendered, and it is no help at all when the view is a further decline, because it adds no downside protection.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
Stock repair improves the odds of getting back to even but does nothing about the worst case. The best outcome is capped: at or above the short call strike the position is worth roughly what the shares originally cost, and no more. The worst outcome is unchanged from simply holding the shares, a loss of the entire original cost basis if the stock goes to zero. The probability of breaking even goes up; the size of the maximum loss does not come down.
How is this strategy affected by the greeks?
This strategy is affected by the greeks in multiple ways. The delta of the option being sold will affect the profits of the strategy as the delta is related to the probability of the option expiring in the money. Gamma works against the position, because as the stock rises toward the short strike the two short calls gain delta faster than the single long call, which is what flattens the payoff above that strike. Vega will affect the value of the option sold with changes in the implied volatility of the stock. Theta will affect the time decay of the option, allowing the trader to collect the credit faster.
In what volatility regime (i.e VIX level) would this strategy be optimal?
This strategy is most optimal when the VIX level is high, as this increases the implied volatility of the stock and thus the value of the option that is sold. Higher implied volatility means a larger credit for the calls sold, so elevated VIX levels generally improve the terms of this strategy rather than argue for waiting.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
In order to adjust this strategy when the trade goes against you, the trader may need to buy back the calls that were sold earlier. That costs money and pushes the breakeven back up toward the original cost basis, so it undoes the repair rather than offsetting the loss on the shares. This strategy can be easy or difficult to adjust depending on the trader’s experience with options trading.
Where does this strategy typically fall in the range of commissions and fees?
Three option contracts are traded to open the repair, one long call and two short calls, so commissions run higher than on a single leg trade and higher again if the position is closed rather than left to expire. The credit from the two short calls is spent on the long call rather than left over to pay fees, so commissions are a real cost of the repair and not something the structure pays for itself.
Is this a good option income strategy?
No. Stock repair is a recovery structure, not an income structure. The one by two version is designed to cost close to nothing rather than to bring in a credit, and the point of the trade is to move the breakeven on shares already held, not to draw a regular payment from them.
How do I know when to exit this strategy?
The trader should exit this strategy when the stock is no longer expected to move in the desired direction. The trader can also exit this strategy if the option is close to expiry and has already collected enough credit from the sale.
How will market makers respond to this trade being opened?
Market makers will typically bid or offer a price to buy or sell the option when it is opened. The market maker will generally provide a better price if they believe the option will become more valuable before the expiry date. The market maker will also be able to provide an implied volatility (IV) which can be useful for the trader in assessing the potential credit they can receive from selling the option.
What is an example (with calculations) of this strategy?
For example, a trader owns 100 shares of ABC bought at $50 and now trading at $40, an unrealised loss of $1,000. Expecting a partial rebound over the next few weeks, the trader buys one $40 call and sells two $45 calls in the same expiration four weeks out, with the two credits roughly paying for the long call, so the repair costs about nothing to put on. Above $45 the shares and the long call together gain $200 per point while the two short calls lose $200 per point, so the position stops moving: it is worth about $5,000 at $45 and still about $5,000 at $60. That $5,000 is exactly what the shares originally cost, so the breakeven on the position drops from $50 to about $45 and the rebound needed to get whole is halved. Between $40 and $45 the long call still has value, so the position gives back $200 per point on the way down. Below $40 every call is worthless and the trader is left holding the shares as before, losing $100 per point, down to a maximum loss of $5,000 if ABC goes to zero. The repair cuts the rebound needed to break even. It does not reduce the downside by a cent, and it hands away everything above $45.
The value of the option will be affected by the underlying stock price and the delta, gamma, theta and vega of the option. The delta is affected by the stock price and time decay and the option value will decrease as the time expires. The gamma will affect the delta and can become beneficial if the stock is expected to move in the correct predicted direction. Finally, the vega affects the implied volatility and will increase the option value if the implied volatility increases.
MarketXLS and How it Can Help
MarketXLS is a powerful financial analysis tool that provides traders and investors the ability to track and analyze stocks in real-time. With MarketXLS, traders can easily monitor changes in the greeks and implied volatilities and make informed decisions when setting up the stock repair options strategy. Traders and investors can also use MarketXLS to quickly scan and filter stocks based on their risk and volatility profile in order to identify the stocks most suitable for this strategy.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic