How to Repair a Losing Long Call Position
By Fri, Feb 19, 2021
While long options positions may have limited risk and unlimited profit potential, they do also have some serious drawbacks. For example, a long call position can be decimated quickly through adverse market movement or the passage of time.
Many inexperienced options traders will allow the value of a long option to go to zero or expire worthless. Needless to say, this is poor risk management and can lead to account destruction pretty quickly.
If you are on the losing end of a long call option, there is a simple method aimed at lowering your break-even point.
What is the Long Call Repair Strategy?
The long call repair strategy aims to take a losing position and turn it into a winning position by lowering the break-even point. Let’s look at an example:
Trader Bob is long a $50 call on stock XYZ with four months until expiration. Bob bought the call with the stock trading at $48 for a premium of $3.00. Shortly after Bob purchased his call option, the stock dipped down to $44.50 per share. Bob’s call went from being worth $3.00 to only being worth $1.25.
Bob can now either:
- A: Sell the call back to the market and lose $1.75
- B: Hope and pray the stock comes back
- C: Double down and buy more calls.
Obviously, none of these choices are ideal. Bob believes the stock will come back up, and with almost four months until expiration, there is time for the option to work. Hoping and praying is never a good idea when it comes to trading. Doubling down may lower the break-even level but does so by adding significantly more risk-also not a good idea. So what can Bob do?
Bob can lower his break-even point without adding significant risk by doing this:
- Selling not one but TWO of the $.50 calls for $1.25. This closes Bob’s original long position and leaves him short one $50 call. Bob takes in a combined $2.50 credit.
- Buy one $45 call for a premium of $2.70.
The details look like this:
Transactions Credit/Debit Net Credit/Debit
Bought one $50 call -$3.00 -$3.00
Sold two $50 calls +$2.50 -$.50
Bought one $45 call -$2.70 -$3.20
Looking at the table above, Bob’s total risk has only increased from $3.00 to $3.20. Most importantly, Bob’s break-even point is now significantly lower. If Bob simply held the $50 original long call option, his break-even level would be $53 per share, almost $10 from the current stock price.
By rolling his long call down into a bull call spread, however, Bob has now lowered his break-even from $53 to $48.20, a significant difference.
What’s the Catch?
There is some downside to such a strategy. First, overall position risk has been increased, albeit not by much. Secondly, the maximum profit potential on the position now is just $1.80. This is because Bob’s net debit for the position is $3.20 while a $45/$50 call spread can have a maximum intrinsic value of five bucks. $5.00-$3.20 premium paid=$1.80 profit potential.
The long call repair strategy may be useful for positions with considerable time until expiration. It can potentially lower the position break-even point while not adding a great deal of risk.
Of course, there may be times when such a strategy will not be feasible due to option values or other factors. Sometimes a bad trade is just a bad trade and it may be best to cut the loss and move on.
