Admit it. Sometimes trades get away from us, right? That’s why controlling risk should be the primary focus when trading options.
Thankfully, when buying options, the contracts have money management built in with the maximum loss limited to the premium paid for that options.
But what happens when an option you bought dramatically loses half of its value in a blink of an eye? A good rule of thumb is to put a stop loss at just below half of the original cost, because mathematically when an option losses half of its value the likely hood of success is small. Anything can happen, but more times than not, either the market has moved significantly in the other direction or time is running out.
There is another way.
There is a options repair hack for long call options gone bad.
The first temptation is to just buy more of the losing play and average down. Unfortunately, the probability of the big recovery needed to profit is very low.
A solution that has a much lower break-even point is to create an option spread.
Here’s an example:
Stock at $93 Buy $95 Call for $3.00 – stock expiration break even is $98
Stock drops to $89 and the $95 Call now worth $1.25
Choice to take a $1.75 loss
Create a bull call spread – buy new $90 Call for $2.75 and Sell 2 $95 Calls for $1.25 each to be net short the higher strike.
Buying the $90 call and selling two $95 calls results in a $90/$95 call spread for a total cost of $325. The net risk was only increased by $25 BUT the expiration break-even was lowered from $98 to $93.25 ($90 strike plus total cost).
The probability of the stock recovering to $93.25 is significantly higher that it getting back to the old break even at $98 nearly 10% above.
The option repair strategy still needs a rebound in the stock, but by creating the spread though less work needs to be done to get back the lost funds. Let me know if this strategy works for you.
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