Chris Tyler
Chris Tyler

How a trader goes about establishing a position is largely a personal matter but is hopefully dictated by common sense. That said, when an option trader is at a loss for more than just words, (i.e. showing a drop in value in their portfolio), it might be more prudent to adjust that paper loss into another position, rather than take the typically ‘correct’ action of exiting.

After careful scrutiny (which hopefully doesn’t rest too heavily on a ‘get even’ mentality) and if conditions dictate, a trader can sometimes improve their chances for profitability - or at least opportunity to break even - by staying the course with an altered position or repair strategy. The simplest adjustment could be to take a long call or long put that’s showing a loss on paper.

If the situation isn’t technically terminal already and the position showing too large a loss, the trader could consider rolling the position into a lower strike bull call vertical or higher strike bear put vertical, if the adjustment can be done for around even money. For instance, if the trader was bullish using a 50-strike call and the stock proceeds to drop, a roll to sell twice as many of those calls (half closing, half opening) and purchase the original contract size on the 45 strike will leave the trader with a 45 / 50 bull call spread. If the original call was bought for $1.50 and the roll is completed for even money, the breakeven point reduces from $51.50 to $46.50.

The above example is generous in its pricing, if not opaque. But it does serve the point of getting option traders to think about alternatives outside the box. Sometimes our own mental constraints, while well-intentioned, do not always serve our best interests. Another possible repair - which goes a step further - would be to take a vertical that’s showing a loss and roll it lower with a long butterfly adjustment.

A less opaque example in (CRM) serves to indicate why repair strategies can be a tricky business, and involves an illustrated purchase of the June 150 / 160 bull call spread for $4.55 on May 26. With shares displaying relative strength compared to the broader market and hitting fresh all-time-highs, the trader puts on the spread with shares closing near 153.55, giving the spread a decent chunk of real value if the stock simply holds those levels through to expiration.

Unfortunately (and maybe chalking up the action to the market’s own case of June Gloom), the highs set on May 26 are never passed and CRM shares begin to feel the drag of the market, falling to about 145 by June 3. Showing a loss of $300 out of the max $455 per spread - and feeling a bit less bullish, but not bearish - the trader decides a modified ‘broken wing’ butterfly might help.

click chart for more detail
click to enlarge

Figure 1: (CRM) Adjusted Bull Call

Opting to roll the June 150 / 160 bull call into the tighter June 145 / 150 bull call is achieved by the following: +1 June 145 call “to open”, -2 June 150 calls (1 to open, 1 to close) and +1 June 160 call “to close.” The net result is an additional small and acceptable debit of $45 and a much lower breakeven of 150.10 compared to 154.55 as shown in Figure 1 above.

Unfortunately, that’s as good as the upside gets in this case. The trader now has a total combined cost of $500 for the two positions, while holding a five point bull call. In the end - and the end happens to be very close at hand in this case - this repair indicates why, more often than not, folding is the better way to play the game, but can be challenged on occasion.

Chris Tyler

Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate