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The stock repair strategy can be used to lower the breakeven point on a previously purchased stock that has dropped in price.  Consider an example where you purchase 100 shares of a stock for $110 per share and it drops to $100 per share, for a loss of $10 per share or $1,000.  Under normal circumstances, you would need the stock to rally 10% back to the original $110 purchase price just to break even.  Using the stock repair strategy allows the trader to lower the break even point by utilizing a ratio option spread.

To explain the strategy, lets find a stock close to $100 per share.  Precision Cast Parts (symbol PCP) is an optionable stock that closed today’s session at $99.11.  Let’s assume that we purchased 100 shares of PCP for $110, and are now down nearly $1,100.  Note the current 52 week high is only $105 so don’t over analyze the example.  Let’s just assume we bought it 2 weeks ago for $110.

To utilize the stock repair strategy, the trader would initiate a ratio spread by purchasing (1) at the money option and selling (2) out of the money options.  Let’s take a look at the December option chain for PCP.

By doing nothing, the breakeven point of PCP is $110.  The stock would need to recover back to the original $110 purchase price for the trader to break even.  But consider the changes to the December expiration day breakeven point after adding a December 1:2 ratio spread at the 100/105 strikes.

• Original stock purchase price $110
• Current stock price $99.11
• Purchase (1) December 100 call for $4.20 (midpoint of bid/ask)
• Sell (2) December 105 calls for $2.30
• Adding the ratio spread results in a credit of $40 (2.30+2.30-4.20)

Note that implementing the ratio spread without owning the stock would result in a naked option leg and unlimited risk.  But both of the (2) 105 calls are covered in this scenario due to the fact that we still have the 100 underlying shares.  Essentially what you have is a covered call plus a vertical call spread.  Consider the following expiration day prices as an example of how the above stock repair strategy example lowers the break even point of the previously purchased stock.

• $80 – All options (100 and 105 strikes) expire worthless.  The unrealized loss is now $3,000 (110 – 80).  This is no different than owning the stock without adding the stock repair strategy options.
• $105 – The loss on the stock is only $500 (110 – 105).  The gain on the 100 strike option is $80 (500-420).  The (2) 110 options expire worthless and the gain on them is the $460 total premium collected.  With a $105 strike price on expiration, the trader is already beyond breakeven and slightly profitable with $40 in profit. (-500 + 80 + 460).

Things to consider when utilizing the stock repair strategy:

• The choice of strike prices for each leg of the ratio spread will change the breakeven point for your particular situation.
• The choice of expiration month will change the breakeven point
• Depending on the expiration day price, tt may be is possible to repeat the stock repair strategy multiple times to collect additional profit.  Consider the example above where the stock closed at $105 on expiration day.  A new stock repair strategy ratio spread could be opened for January or other expiration month.
• Options can be closed, opened, rolled, or morphed at any time.  It is not necessary to hold them until expiration.

For more information on trading and adjusting options positions, check out the following highly recommended book:

The Option Trader Handbook: Strategies and Trade Adjustments (Wiley Trading) by George Jabbour