RIMM – Stock Repair Strategy in Action
Given the stellar performance of the equities market over the past two years it’s safe to assume most stocks are leaps and bounds above their 2009 bear market lows. But that doesn’t apply when it comes to poor performers like Research In Motion (NASDAQ: RIMM). Its performance in recent months has been absolutely horrendous. As a result of this precipitous drop RIMM has returned to its pivotal lows hammered out at the end of the recent bear market.
Market participants will be watching closely to see if the bulls come out in force to defend this key line in the sand. If it fails to hold, a new bout of selling is likely to seize the stock. In the event the $35 level does hold and RIMM begins to stabilize, investors with losing stock positions may consider implementing an options trading, stock repair strategy to increase the chances of making their money back.
Suppose you purchased shares of RIMM around $54. If you desired to remain long RIMM in an attempt to recoup the loss you have two primary choices. First, you could hold on and hope — a scenario I find highly unlikely anytime soon. Second, you could double down by purchasing more shares at current levels. The advantage there is you drop your average cost basis (break-even) to around $47. That’s smart but it also doubles the amount of risk in the trade. Wouldn’t it be nice to lower the break-even without adding risk? This option stock repair strategy accomplishes just that.
Find more option analysis and trading ideas at Options Trading Strategies.
This repair strategy can be entered by simply adding a 1×2 call ratio spread to your long stock position. You can think of it as selling a covered call and buying a call spread simultaneously. If you purchased 100 shares of RIMM at $54, then you have an unrealized loss of $1500 with the stock at $39, and you need a $15 rise to reach the break-even point as shown in the following risk graph.
Source: MachTrader
For purposes of this example prices are rounded. Check the options chains for current prices.
To enter a repair strategy we could buy one RIMM Sep 40 Call for $3.40 while selling two RIMM Sep 47.50 Calls for $1.70 apiece. By doing this we’re essentially selling a Sep 47.50 covered call and buying a Sep 40 – 47.50 call spread. Because the credit received from selling the two 47.50 calls was sufficient to pay for the long 40 call, this repair strategy is entered at no additional out of pocket cost. The affect on the stock position is illustrated in the following risk graph.
In the new position we only need a rise to $47.50 instead of $54 to recoup the loss. From a percentage standpoint this means RIMM only needs to rise 21% instead of 38% from current levels. Keep in mind this strategy does nothing to decrease the remaining downside risk, so it’s not really a hedging strategy as much as it is a repair helping you make money back quicker.
The stock repair strategy seems to work best with stocks that have fallen 10% to 20% from the purchase price. If you allow the stock to decline too much it can be very difficult to structure a repair to adequately recoup your loss. It’s also important to have a basic understanding of risk graphs so you can see the affects of the repair on the position.
At the time of this writing Tyler Craig had no positions on RIMM.
Follow Tyler Craig on Twitter@TylersTrading.
