How to Use Stock Options to Lower Our Breakeven Price Points: The Stock Repair Strategy – October 16, 2023
Stock options can be used to mitigate losses on shares we own at a higher price than current market value. Some investors will buy more shares at the new lower price and average-down, thereby adding more cash to an already losing trade. This article will detail how stock options can be leveraged to lower the breakeven price point after shares of Axon Enterprise Inc. (Nasdaq: AXON) plummeted after a disappointing earnings report. This trade did not start as an option trade but call options are used in an attempt to mitigate the substantial unrealized loss at the time of the strategy implementation.
Chart of AXON showing price decline after the 5/12/2023 ER (pre- and post-earnings)
How the Stock Repair Strategy works
- Buy 1 x near-the-money call option ($200.00 long option)
- Sell 2 x out-of-the-money call options with a strike between current market value and original purchase price ($210.00 strike short calls)
- The short calls will fund the long call
- Known as a 1 x 2 ratio call spread
Calculations using the BCI Stock Repair Calculator
- The breakeven price point is reduced from $215.25 to $207.57 (blue ovals)
- Before stock repair, the loss per-share is $13.86 (green arrow)
- The pre-stock repair % stock loss is 6.44% (red arrow)
- The net option credit after stock repair is $0.12 per-share (purple arrow)
- The blank cells on the top right are used for final calculations after expiration
Final calculations: 1 scenario if share price closes between the 2 call strikes ($205.00)
Note the following (red & blue ovals):
- Per-share loss is reduced from $13.86 to $5.13
- % share loss is reduced from 6.44% to 2.38%
- The spreadsheet will calculate final results for all other scenarios
Discussion
The stock repair strategy will lower our breakeven price point by adding little or no cash to the trade. There may actually be an option credit in many cases. We must be willing to sacrifice potential upside profit and understand that we are still susceptible to further share price decline.
Author: Alan Ellman