What is Stock Repair strategy?
Nilesh Jain
Last Updated: 16th December 2022 - 07:00 pm
As the name suggests, the Stock Repair strategy is an alternative strategy to recover from loss that a stock has suffered due to fall in price. The Stock Repair strategy helps in recovering losses with just a moderate rise in the price of the underlying stock.
Why to Initiate Stock Repair strategy?
Stock Repair strategy is initiated to recover from the losses and exit from loss making position at breakeven of the underlying stock.
Who can initiate Stock Repair strategy?
A Stock Repair strategy should be implemented by investors who are looking forward to average their position by buying additional stocks in cash when the underlying stock price is falling. Instead of buying additional stock in cash one can apply stock repair strategy.
Stock Repair strategy?
A Stock Repair strategy should be initiated only when the stock that you are holding in your portfolio has corrected by 10-20% and only if you think that the underlying stock will rise moderately in near term.
How to Construct the Stock Repair strategy?
- Buy 1 ATM call
- Sell 2 OTM calls
Stock Repair strategy is implemented by buying one At-the-Money (ATM) call option and simultaneously selling two Out-the-Money (OTM) call options strikes, which should be closest to the initial buying price of the same underlying stock with the same expiry.
| Strategy | Long Stock, Buy 1 ATM Call and Sell 2 OTM Call |
| Market Outlook | Mildly Bullish |
| Motive | Recover loss with limited risk |
| Break even | (Strike price of buy call + strike of sell call + net premium paid)/2 |
| Risk | Net premium paid, Drop in price of holding stock |
| Reward | Average of difference between strike price-net premium paid |
| Margin required | Yes |
Let’s try to understand with an example:
| DISHTV earlier Bought at Rs | 100 |
| Quantity bought | 7000 |
| DISHTV Current spot price (Rs) | 90 |
| Buy 1 ATM Call of strike price (Rs) | 90 |
| Premium paid (Rs) | 5 |
| Sell 2 OTM Call of strike price (Rs) | 100 |
| OTM call price per lot (Rs) | 2 |
| Premium received (Rs) (2*2) | 4 |
| Break even | 95.5 |
| Lot Size | 7000 |
| Net Premium paid (Rs) | 1 |
For example, an investor Mr. A had bought 7000 shares of DISHTV at Rs 100 in April but the price of DISHTV has declined to Rs 90, resulting in to notional loss of Rs 70,000. Mr. A thinks that price will rise from this level so rather than doubling the quantity at current price, here he can initiate the Stock Repair strategy. This can be initiated by buying one May 90 call for Rs 5 and selling two May 100 call for Rs 2 each. The net debit paid to enter this spread is Rs 1 amounting to Rs 7000, which will be the maximum loss from repair strategy that Mr. A will face if DISHTV falls below Rs 90.
If DISHTV expires at 80 level then both the calls would expire worthless, resulting in loss of the debit paid of Rs 7000 as the net cost to initiate Stock Repair strategy is Rs 1 per lot. Had Mr A doubled his position at 90 level then he would have lost Rs 70,000 (10*7000). This shows he is much better off by applying this strategy.
If DISHTV expires at 100 level then this would be the best case scenario where maximum profit will be achieved. May 90 call bought would result in to profit of Rs 5 where as May 100 call sold will expire worthless resulting in to gain of Rs 4. Net gain would be Rs 63,000 (9*7000).
Followings are the two scenarios assuming Mr A has implemented the Stock Repair strategy whereas Mr B has doubled his position at lower level. For the ease of understanding, we did not take in to account commission charges.
| Stock Repair | Normal Averaging | |||||||
| DISHTV expires at | Payoff from stock holding at Rs 100 | Payoff from Repair Strategy | Net payoff of Mr. A | Payoff from stock holding at Rs 100 | Doubling down position payoff | Net Payoff of Mr. B | ||
| 70 | (2,10,000) | 7,000 | (2,17,000) | (2,10,000) | (1,40,000) | (3,50,000) | ||
| 80 | (1,40,000) | 7,000 | (1,47,000) | (1,40,000) | (70,000) | (2,10,000) | ||
| 90 | (70,000) | 7,000 | (77,000) | (70,000) | 0 | (70,000) | ||
| 100 | 0 | 63,000 | 63,000 | 0 | 70,000 | 70,000 | ||
| 110 | 70,000 | (7,000) | 63,000 | 70,000 | 1,40,000 | 2,10,000 | ||
Comparison:
| Mr. A initiated stock repair strategy | Mr. B Doubled his position at lower level | |
| Margin | Only margin money is required to initiate stock repair strategy | Full amount has to be paid in cash for taking delivery of stock |
| Interest Loss (1 month) | 1,50,000*0.08/12=1000 | 630000*0.08/12= 4200 |
| Risk | Risk associated is limited | It involves high risk when the stock price falls |
| Brokerage | Brokerage in Options is comparatively less. | Brokerage paid to initiate position is higher as compared to Options. |
The Payoff chart:
Analysis of Stock Repair strategy:
The Stock Repair strategy is suitable for an investor who is holding a losing stock and wants to reduce breakeven at very little or no cost. This strategy helps in minimizing the loss at very low cost as compared to "Doubling Down" of position.
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