More recently, I learned about the repair strategy to accelerate the breakeven point of stocks that we are sitting on losses. I have several of those stocks, so I thought I will give it a try. The idea behind the repair strategy is to buy a call at a strike price close to the current price, and sell 2 calls at a higher strike price. The premium collected from the selling of 2 calls would typically cover the purchase of the 1 call option, so the position is "free". You can also read more about the repair strategy with example in the link below.
https://www.investopedia.com/articles/trading/08/repair-strategy.asp
Once you have established the positions, there are now a few scenarios:
1. Stock price remains at current price or go lower. In this case, the options expire worthless, and we get to keep any premium difference.
2. Stock price goes up between the 2 strike prices of the 2 call options. In this case, the call option you purchased would increase in value, and you can sell it for a profit. On the other hand, the 2 call options you sold would expire worthless and you get to keep the premium from the writing of the option. This effectively brings down the cost of your original stocks.
3. Stock price goes above both strike prices. In this case, you would exercise the call option at the lower strike price, and together with the original stocks that you own, cover the 2 call options you sold. In this scenario, you would be able to breakeven on the stock (depending on the choice of the 2 strike prices), but you could potentially miss the rest of the upside if the price continues to increase.
So as a real and specific example, I actually own 100 shares of Shopify (SHOP) which I bought some time ago at a price of $63.50. When I entered into the repair position, the share price of SHOP was around $40, and I was sitting on a significant loss of $23.50.
I then bought and sold the following 1 year call options.
By selling the 2 $50 call options at $5.90 and selling the 1 $40 call option at $9.55, I effectively deployed the repair strategy and pocket $225 in the process. In theory, if the price of SHOP goes up to $50 at the expiry date then what happens is that the $40 call allows me to buy another 100 shares of SHOP at $40 each, bringing my total to 200 shares of SHOP at an average cost of $51.75. At the same time, the 2 $50 call options would be exercised, and I would have to sell my 200 shares at $50 each. My losses then would be $1.75 per share for 200 shares or $350 instead of $13.50 per share for 100 share or $1350 if I had not used the repair strategy. Furthermore, should the price of SHOP increase further to say $80, I would not be able to benefit from it, and I will have to remain with the $350 loss instead of enjoying a gain of $16.50 per share for my original 100 shares.
In the last week, SHOP announced that they will be increasing their prices for their subscription plans across all tiers. The market responded positively to this announcement, and their share price jumped $10 or 25% in a single week. Now interestingly, I thought this would mean I can close my positions in SHOP at near breakeven, but the option prices tell a different story. In fact, with the options, it has exacerbated my losses by another $400! I think this is because the duration of the option is still so long, with expiry almost a year away, so the time value of the options distorts the intrinsic value of the options.
So a few lessons learned already from here. First, the choice of the strike price is important. Since I chose $50 to be the higher strike price, which is less than half between my initial breakeven price and the current market price when I entered into the positions, I would not be able to breakeven and will always result in a loss. Second, the duration of the option also plays a strong part. Since I chose 1 year options, and the prices moved up so quickly, I don’t think I am able to benefit from the strategy now that the price has reached my strike price.
I am not entirely sure what to do at the moment. I haven't closed the postitions. I won't know of course if SHOP will continue to climb or it will pull back again, especially after their earnings call on Feb 15. So if anyone has any thoughts or suggestions, I will be happy to hear and learn.
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