There is nothing worse than making a new stock purchase and then watching the stock swiftly move to the downside. Thankfully, there is an option strategy to use on something like PayPal stock that could help speed up the recovery process. It's called a stock repair strategy.
XThe idea with the stock repair strategy is that the investor can reduce the break-even price without adding any more capital to the trade. There is no additional downside risk with the trade.
Stock Repair Strategy For PayPal Stock
PayPal (PYPL) serves as a good example, as it has been under pressure in recent months.
Assuming a trader bought into PayPal stock at 230, and didn't employ the golden rule of loss-cutting, they would be sitting on a considerable loss. With a close at 184.89 yesterday, that's nearly a 20% hit.
As a stock trader, now you need about a 25% move in the stock just to get back to break-even.
However, by using options on PayPal stock, we can lower the break-even price to 210. Even better, this strategy doesn't add extra risk to the trade.
Here's how it can be done:
Buy one Feb. 190 call @ 12.55.
Sell two Feb. 210 calls @ 6.30.
Mechanics Of The Trade
Buying the 190 call costs $1,255 and selling two of the 210 calls receives a credit of $1,260. The net result for placing the trade is a $5 credit.
Because the trade is placed for a credit, you aren't adding risk to the downside. Consider that if PayPal stock stays below 190, the call options expire worthless and the trader still owns the 100 shares of stock. You aren't any worse off for the option trade. But, and this is important, you still have the risk from your initial PayPal stock position.
Let's say PayPal stock rebounds sharply over the next few months. If the stock ends up at 190 to 230, the combined stock repair option strategy will outperform the pure stock position.
This will effectively reduce your break-even price to 210. What's the trade-off? Any potential gains in PayPal stock above 230 are lost.
Stock Repair Strategy Takeaway
So the stock repair strategy on PayPal is useful for an investor holding a losing position who simply wants to get back to break-even and get out.
It helps the investor reduce their break-even price for little or no cost.
But you aren't protected from further downside in PayPal stock. Still, it's a more attractive risk management strategy than "doubling down."
When placing this stock repair strategy in PayPal, the investor achieves an earlier break-even price, without adding risk, but gives up further potential upside on the stock.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a masters in applied finance and investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
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