Hi Bob,
The Repair is feasible for a stock that is down 10-20 pct down but there's no reason why you can't use it when you buy the stock in order to increase upside gain somewhat.
For every 100 shares long , add a 1x2 Ratio Spread (buy one call at a lower strike and sell two calls at a higher strike). The total position will be equivalent to a covered call and a bullish vertical call spread. All short calls are covered (use a combo order for opening rather than legging in).
(1) The higher strike premium should be at least 1/2 the cost of the lower strike so that the Ratio costs nothing. A credit is even better. If the Repair does not work out, you'll have the same downside potential as if you had done nothing, namely just holding the stock and hoping for a recovery. To the downside, a failed no cost Repair has no impact on the overall equity position.
(2) To break even, if using an ATM long call, the short strike should be approximately midway between the current price and your break even price. IOW, the width of the vertical spread (the difference in strikes) should be about 1/2 the amount of your paper loss for you to break even.
To select a Repair, look at a near expiry. Go out a week (or a month) at a time until you find a pair that meets the no cost requirement (1) and provides break even (2). These criteria are not etched in stone. If you want to pay a small premium for the Repair or if you want to shoot for a price less than break even, go for it.
Implied volatility affects Repair's cost. The lower it is, the more costly the Ratio. If higher (for example, pre earnings), the larger the credit which may then enable you to use lower strike and have a higher probability of the upper strike being reached and the Repair succeeding.
You DO NOT want to go out many months with a Repair because prior to expiration, short calls retain time premium and they will be a drag on the long call gain, hindering the Repair from achieving its full value prior to expiration. To get the maximum amount from the Repair at expiration, the underlying would have to be at or above the upper strike. To get the maximum amount from the Repair prior to expiration, the underlying would have to be well above the upper strike in order to drive the short calls to parity (no time premium remaining).
You can also use this strategy for brand new stock purchase. This is not a Repair since you aren't underwater (paper loss). For example, if XYZ is $70, if you could execute a $70/75 ratio combo for no cost and if XYZ was above $75 at expiration, you'd net $80. From $70 to $75 you would make $2 for every dollar that XYZ rose ($1 on the stock and $1 on the long call). So at $71 at expiration, you'd net $2. At $72 you net $4, all the up to $75 where you'd net $10.
You can read more about this by Googling "Repair Strategy"
I'll get back to you on the AT&T later. |
