If you’ve ever wanted to know how to recoup a loss on shares of stock you’re holding, read the following article. It’s a real life step-by-step example using 100 shares of Apple stock that just dropped 6%.
Earlier this week, Apple Inc. (AAPL) disappointed the investing community by doing the unlikely – missing Wall Street‘s fourth-quarter earnings estimates. As a result, the shares have plummeted more than 6% since the report, with AAPL giving up former support at the $400 level. Bargain buying appears to be keeping AAPL afloat for the time being, but the stock has been unable to quickly bounce back above this psychologically important area.
Daily AAPL chart with 50-day moving average
Now, you could wait for buying pressure to build once again and eventually push AAPL back to pre-earnings levels. However, if you are not afraid to add a little risk to your portfolio, you could recoup those losses much more quickly through options trading. The best part is that this strategy won’t cost you any more capital, and could even allow you to immediately offset some of your post-earnings AAPL losses.
The options play I’m talking about is commonly known as the stock repair strategy, and it is utilized by stock traders who remain firm in their initial bullish assessment. In other words, if you have lost faith in the stock’s ability to rebound, this strategy is not for you. With AAPL boosting its fiscal first-quarter earnings expectations, it should be only a matter of time before the stock begins to head higher once again.
The Set Up
In the mean time, AAPL traders can take full advantage of the leverage offered by options in order to more quickly recoup some of their losses. Let’s say that your AAPL position totaled 100 shares heading into the company’s earnings report. As noted above, the stock plunged more than 6% from a pre-earnings close at $422.24 to yesterday’s finish at $395.31.
With the company lifting its first-quarter guidance, you believe that the stock will eventually come around. But, you are concerned about the current mood on Wall Street, the situation in Europe, and the potential for technical resistance near AAPL’s all-time high at $426.70. To initiate the stock repair strategy, you will retain your 100 AAPL shares (obviously), while simultaneously purchasing one December $400 call (which was last asked at $18.60) and selling two December $420 calls (which were last bid at $10.25).
When the dust settles, you should end up with a net credit of $1.90, or $190 per set of contracts (aside from commissions and margin requirements). Furthermore, both of your sold December $420 calls are essentially covered: one by the 100 AAPL shares in your portfolio, and one by the purchased December $400 call. As you can see, while you actually get paid (via the net credit) to enter this stock repair strategy, you run the risk of having your 100 AAPL shares called away if the stock bounces back too sharply.
The Results
There are three potential outcomes for the stock repair strategy. First, AAPL shares fail to recover from their recent set back and extend their losses through December option expiration. In this scenario, the options used to construct the stock repair strategy will expire worthless, but you will retain the net credit of $1.90 received upon entering the trade. Depending on how far AAPL’s losses extend, this credit could be of little comfort, but at least you didn’t pay more to enter the position.
