My Favorite Way to Fix a Trading Mistake

You have probably been in the situation every investor dreads — seeing your stock tumble 20% or more from your purchase price.

I hate when this happens, too, but it’s a natural consequence of being an active investor or trader.

However, just because you’re faced with a 20% loss doesn’t mean you have to accept it.

One of my mentors, now a billionaire, asked during lunch recently how my trading was going.

"Great," I said, "I’ve been on a pretty long winning streak."

11-for-11 so far …

Gold, bonds, stocks … everything across the investment world seems trapped in a trading range. But that doesn’t mean you can’t profit.

In fact, I’ve uncovered a "Secret Gold Account" that can help you make money in any market conditions … and so far this year, it’s been working like gangbusters.

Since the beginning of the year, this system already could have handed you nine "income checks" of up to $3,390!

 

Plus, we’ve already collected over 70% in cumulative gains using our "gold accelerator" method … and we’re just getting started. This video reveals how we did it.

But be sure to watch it before 11:59 p.m. Eastern tonight to see how you can claim a special $1,200 gift just for watching!

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He shocked me by saying "Well, that’s fine, I suppose, but seeing how you’re not making many mistakes — you might not be trading enough. Even the most-successful Wall Street traders are wrong almost half the time."

Some of you may think watching a stock take a 20%-30% dive will not happen to you because you use stop orders to prevent such losses.

Well, you’re wrong. Even if you use stop orders, large losses can occur between trading days (known as "gap downs").

For example, a stock can close at $75 one night and open the next day at $60. If you have a stop order in at $75, you will sell at $60. If you have a stop limit at $75, your order won’t be filled at all.

In either case, the stop did not work as expected and you’re down!

Fortunately, with the wise use of options, you can sometimes get out of these precarious positions with ease. To do so, you need to understand the option repair strategy.

Option Repair Strategy

This strategy is a very clever, yet simple strategy. Many investors would not think to do it, which is what makes it a powerful tool to keep within close reach in your personal trading arsenal.

The repair strategy does make a couple of assumptions …

  • First, you must be at least moderately bullish on the stock over the short term. If you think the stock is heading south, you are probably best selling at a loss or buying protective puts as a full or partial hedge.
  • Second, you are willing to exit the position by just breaking even (or close to it). In other words, this strategy is not a high-profit one; it is designed to simply get you out of a bad situation. So if you’re in a losing stock position and thinking, "Just get me my money back and I’ll walk away," then this may be the strategy for you.

With the above assumptions, we can accomplish a break-even with the repair strategy.

Here’s how the strategy works.

The ‘Magic’ Formula = 10 x 20

Say you buy 1,000 shares of stock at $50 and it is now trading for $40 — down 20%.

You think the stock will rise to $45 but not much past that; remember, you must be somewhat bullish in order for the strategy to work.

The way to design a repair strategy under these assumptions is to look for a ratio call spread you can write for free (before fees and commissions).

How do you do that? In our example, we may buy ("buy to open") 10 call options at the $40 strike price for $5 … and also write ("sell to open") 20 $45 calls for $2.50.

Here are the transactions in this example:

Notice that we bought 10 and sold 20 — that’s a ratio call spread. Normally, a "ratio writer" (because more calls were written than purchased) is subject to unlimited upside risk.

However, because you already own shares, you can cover 10 of the short $45 calls with your stock and the remaining 10 contracts with the $40 call.

Effectively, you are writing 10 $45 contracts as a covered call, plus entering 10 $40/$45 bull spreads. Because you can write twice as many calls as we need to purchase, the long $40 calls could cost you nothing!

In most cases, you will be limited to no more than a $5 difference in strikes. In other words, this strategy will usually not work by buying the $40 and selling the $50 calls, because that is a 10-point difference in strikes.

Now, if the stock does move to $45 at expiration, the long shares will be worth only $45 (the short $45 calls will expire worthless). The $40/$45 bull spread will be worth $5 points for a total of $50 points.

Here are the transactions in detail:

In effect, you have leveraged your account for an upside move for no money down or additional risk. The trade-off is that you cap your upside return.

But if you are not long-term bullish, then capping the upside in exchange for break-even may make perfect sense for a particular situation.

In the example above, does the stock need to close at exactly $45 in order for the strategy to work? No, it will work as long as the underlying stock rises to $45 or higher.

Say the stock rallies all the way back to $50 at expiration. Now your long stock is worth +$45 (remember, you have a $45 covered call against the shares), and your long $40/$45 call spread is worth +$5 for a total of $50.

Any stock price above $45 at expiration will result in the total position being worth $50.

It is also helpful to look at the various option strikes and months, known as option chains, to help make your decision as to which options to buy and sell. You can get these through most brokerage firms or from the Chicago Board Options Exchange.

The option repair strategy is yet another demonstration of the versatility of options. We can take these "risky" options and use them to leverage our returns for no money down. If you take the time to learn and understand these instruments, you will greatly improve your portfolio performance.

Watching your chickens,

James DiGeorgia

P.S. A recent WSJ article said, "The stock market is acting like a tease." Stocks, gold, bonds … everything seems to be stuck in a trading range. But just because the markets are stuck doesn’t mean you can’t profit. Click here to learn how my "Secret Gold Account" has already gone 11-for-11 this year … spinning off over $3,300 in income and 70% in gains!