Repair & Exit Strategies Presented by The Options Industry Council www.OptionsEducation.org

Repair & Exit Strategies Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained by contacting your broker or The Options Industry Council at One North Wacker Drive, Chicago, IL 60606. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.

Presentation Outline Repair & Exit Strategies Stock Repair Strategy general statements and issues Stock Repair Strategy what it is and when to use it advantages and disadvantages Exit Strategies long stock position long call or put position short call or put position short option – pin risk Concluding Comments

Repair & Exit Strategies Before you exit you must enter the market having a plan is most important foresee possible outcomes fully understand your risk vs. reward understand ramifications of long vs. short options

Repair & Exit Strategies Before you exit you must enter the market having a plan is most important foresee possible outcomes fully understand your risk vs. reward understand ramifications of long vs. short options Discipline what loss would be tolerable? what profit would be sufficient? predetermining both will help your exit

Repair & Exit Strategies After position established – profits or losses Stock or option investor – you have choices realize a profit or increase unrealized profits protect original investment protect yourself from (further) losses

Repair & Exit Strategies After position established – profits or losses Stock or option investor – you have choices realize a profit or increase unrealized profits protect original investment protect yourself from (further) losses Be creative and flexible – many choices available Exit/repair method should fit the situation no one method always the best You don’t have to just hold and hope

Stock Repair Strategy

Stock Repair Strategy Buy Stock and it Declines – What to Do? Or……. Do nothing (hold and hope) stock must rally to purchase price to recover investment downside risk remains same – original investment Double up (buy more) lowers upside break-even and increases downside risk additional cash required Or…….

Stock Repair Strategy Buy Stock and it Declines – What to Do? Establish stock repair with call options lowers break-even on upside little or no additional funds required downside risk remains same (original stock purchase) trade-off – upside profit potential capped

Stock Repair Strategy What is it? own 100 underlying shares overlay ratio call spread: buy 1 call and sell 2 (higher strike) call spread – little or no net cost (credit possible)

Stock Repair Strategy What is it? No uncovered calls own 100 underlying shares overlay ratio call spread: buy 1 call and sell 2 (higher strike) call spread – little or no net cost (credit possible) No uncovered calls 1 short call covered by 100 underlying shares 1 short call covered by long call

Stock Repair Strategy What is it? No uncovered calls Investor wants own 100 underlying shares overlay ratio call spread: buy 1 call and sell 2 (higher strike) call spread – little or no net cost (credit possible) No uncovered calls 1 short call covered by 100 underlying shares 1 short call covered by long call Investor wants to possibly recover original investment (at lower break-even) no additional downside risk and little to no additional cash

Stock Repair Strategy Generally best after modest stock decline Choosing strikes – rule of thumb buy 1 At-the-money (ATM) call sell 2 calls with higher strike – Out-of-the-money (OTM)

Stock Repair Strategy Generally best after modest stock decline Choosing strikes – rule of thumb buy 1 At-the-money (ATM) call sell 2 calls with higher strike – Out-of-the-money (OTM) Expiration month? “Keep it short” – why? May choose longer-term for less cost Paying debit for ratio call spread? consider minimal cost vs. upside benefits

Stock Repair Example Buy 100 XYZ at $70 – now $60 stock loss = $10

Stock Repair Example Buy 100 XYZ at $70 – now $60 stock loss = $10 Investor thinks XYZ will move to $65 in next 2 mos. Establish XYZ 60/65 call spread – 1 by 2 buy 1 60-day XYZ 60 call at $3.50 sell 2 60-day XYZ 65 calls at $1.75 $3.50 paid – $3.50 (2 x $1.75) received = no cost Further downside loss from stock owned no downside risk from options

Stock Repair Example At Expiration XYZ at $60 or below all options expire worthless – no profit/loss Additional loss on original stock purchased is possible XYZ between $60 and $65 loss on stock + gain on options = partial loss Not including commissions

Stock Repair Example At Expiration XYZ at $65 or higher $500 loss on stock (purchased at $70) $500 profit on options (spread initially cost $0) Bullish 60/65 call vertical spread worth $500 $65 = new break-even (vs. $70 for stock purchase)

At Expiration 50 (2,000) (350) 350 55 (1,500) 60 (1,000) 62 (800) Long 100 shares XYZ @ $70 Long 1 XYZ 60 call @ $3.50 Short 2 XYZ 65 calls @ $1.75 XYZ Stock Profit (Loss) 1 XYZ 60 call 2 XYZ 65 calls Net 50 (2,000) (350) 350 55 (1,500) 60 (1,000) 62 (800) (150) (600) 65 (500) 150 70 650 (650) 75 500 1,150 (1,650) 80 1000 1,650 (2,650)

Stock Repair 70 80 65 60 Long XYZ stock 55

Stock Repair 70 80 Break even 65 Stock Repair 60 Long XYZ stock 55

At Expiration Original objectives met downside loss limited to original stock purchase upside stock break-even reduced from $70 to $65 no additional funds were required (with this example)

Considerations for Repair Things to consider with stock repair strategy strike prices – cost for spread and new break-even? expiration – how much time for stock to recover? option prices – do currently available make sense? In this example, no additional gain potential above $65 Commissions It may cost money to initiate this trade

Collar for a Long Stock Position Exit Strategies Collar for a Long Stock Position & Covered Call

Profitable Long Stock Position - Collar Buy stock – price increases protect unrealized profits – defer profitable stock sale Collar buy (traditionally) OTM protective put sell (covered) OTM call – finances cost of put debit, zero cost or net credit

Long Stock Position with a Collar Stock goes lower shares protected by long put, but there is risk between current price and strike price, and any possible debit (cost) to initiate Stock goes higher participate from current price until stock reaches strike price of call option sold early assignment of option possible, which may be taxable event

Long Stock Position with a Collar – + Collar Long Stock Limited Profit Loss 2 Commissions: 1 for Call and 1 for Put

Covered Call Stock Price Increases – Possibilities Above strike at or near expiration – do nothing accept assignment original goal met – stock sale at call strike price realize maximum profit Above strike before expiration – close position no longer bullish – buy back call and sell stock liquidate = capital available for other investment may be giving up call time value

Covered Call Stock Price Increases – Possibilities Above strike before expiration – consider roll retain stock – still moderately bullish roll up: more upside potential roll out: more time value and time until expiration roll up and out: more upside and time Above strike before expiration – close call only still bullish – retain stock and buy back call stock gain may cover cost of call repurchase no assignment possibility

Roll Up and Out - Example You own 100 shares of XYZ at $31 You sell the 35 strike call for $2.00 Stock at $34 near expiration You now think stock may go 10% higher ($37.50) Current price of 35 strike call is $1.05

Roll Up and Out - Example You own 100 XYZ and sold the 35 call at $2.00 Stock at $34 one week before expiration Buy one week 35 strike call at $1.05 (to close) Sell five week 37.50 strike call at $1.05 (to open) You rolled up in strike price You rolled out in time

Covered Call Stock Price Declines – Possibilities Below strike at/near expiration – do nothing still moderately bullish – retain stock and call expires no longer bullish – let call expire and sell stock consider selling another call after expiration consider stock repair after expiration

Covered Call Stock Price Declines – Possibilities Below strike at/near expiration – do nothing still moderately bullish – retain stock and call expires no longer bullish – let call expire and sell stock consider selling another call after expiration consider stock repair after expiration Below strike before expiration – consider roll roll down: more premium income roll out: more time value and time until expiration roll down and out: more income and time

Long Call or Long Put Position Exit Strategies Long Call or Long Put Position

Long Call or Put Option Price Increases – Possibilities At or near expiration – close position sell options – free-up cash to invest elsewhere Before expiration – partially close position sell enough to recover original investment bought 10 @ $6 – sell 6 @ $10 = 4 “free” options Before expiration – consider rolling buy options with total cash received from sale buy options with only profits = “free” new options

Long Calls Option Price Increases – Spread Long call – convert to bull call vertical spread sell call (2nd leg) with higher strike – take in premium now limited upside profit potential original downside risk reduced

Long Calls Option Price Increases – Spread Example bought 1 XYZ 50 call @ $4.00 XYZ now at $58 – XYZ 50 call now at $8.30 sell 1 XYZ 60 call @ $1.50 – same expiration upside potential: ($60 - $50) - ($4 - $1.50) = $7.50 downside risk reduced: $4 - $1.50 = $2.50

Long Call or Put Option Price Decreases – Possibilities Before expiration – close position accept outlook on underlying as incorrect sell position – cut losses while options have value Before expiration – consider rolling roll down, roll out or roll down and out Before expiration – double up convinced outlook on underlying good until expiration willing to devote more cash be comfortable with (can afford) increased risk

Short Call or Short Put Position Exit Strategies Short Call or Short Put Position

Naked Short Call or Put Option Price Increases Short Call very risky, Short Put risk of stock ownership Can be large margin requirements Some brokers require special approval level

Short Call or Put Before expiration – close position have a predetermined limit for loss close out (buy back) position Before expiration – leg into spread before damage too great – prevent disaster reduce damage from unfavorable move reduce already limited potential profit

Naked Short Put – Stock Lower Before expiration – convert to bull put spread buy put (2nd leg) with lower strike limited profit potential is now reduced reduced original downside risk Example sold 1 XYZ 50 put @ $3.00 XYZ now at $46 – XYZ 50 put now $5.50 buy 1 XYZ 45 put @ $2.00 – same expiration downside risk reduced to difference in strike prices 50 - 45) = $5.00 (less $1.00 net credit = $4.00) upside profit reduced to net credit: $3 - $2 = $1.00

Short Call or Put Assignment Risk at Expiration Short an in-the-money call or put at expiration assignment can be expected Short an at-the-money call or put at expiration long holder may choose to exercise assignment possible – “pin risk”

Short Call or Put Assignment Risk at Expiration Managing pin risk assignment acceptable – do nothing assignment not acceptable – consider closing short at minimal cost as market closes last trading day be vigilant as expiration nears – don’t be surprised

In Conclusion

Concluding Comments Before you jump into the market consider how you might get out Know in advance both your tolerance for risk and acceptable profit Don’t be afraid to admit you are wrong and cut losses No one exit strategy is the best – investigate and be open to many possibilities No buying power in your account can reduce flexibility on exit

1-888-OPTIONS www.OptionsEducation.org