1. Repair & Exit Strategies Presented by The Options Industry Council

2. 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
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.

3. 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

4. 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

5. 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

6. 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

7. 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

8. Stock Repair Strategy

9. 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…….

10. 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

11. 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)

12. 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

13. 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

14. 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)

15. 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

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

17. 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

18. 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

19. 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)

20. At Expiration 50 (2,000) (350) 350 55 (1,500) 60 (1,000) 62 (800)
Long 100 shares $70
Long 1 XYZ 60 $3.50
Short 2 XYZ 65 $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)

21. Stock Repair 70 80 65 60
Long XYZ stock 55

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

23. 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)

24. 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

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

26. 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

27. 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

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

29. 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

30. 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

31. 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

32. 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 $ (to close)
Sell five week strike call at $ (to open)
You rolled up in strike price
You rolled out in time

33. 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

34. 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

35. Long Call or Long Put Position
Exit Strategies
Long Call or Long Put Position

36. 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 $6 – sell $10 = 4 “free” options
Before expiration – consider rolling
buy options with total cash received from sale
buy options with only profits = “free” new options

37. 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

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

39. 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

40. Short Call or Short Put Position
Exit Strategies
Short Call or Short Put Position

41. 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

42. 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

43. 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 $3.00
XYZ now at $46 – XYZ 50 put now $5.50
buy 1 XYZ 45 $2.00 – same expiration
downside risk reduced to difference in strike prices
) = $5.00 (less $1.00 net credit = $4.00)
upside profit reduced to net credit: $3 - $2 = $1.00

44. 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”

45. 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

46. In Conclusion

47. 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

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