Time to Repair Your Portfolio

The 2nd Quarter has ended and markets have posted their worst start of the year since 1970. After six months of prices moving lower many stocks have retraced more than half of the move up from the COVID lows and some, the full move and more! This can be disheartening to a short term investor or one just getting started. For many of them it will be a waiting game, looking for the market to confirm that a bottom has formed, before jumping back in. But for many investors who started their journey in the markets well before the COVID era, the story has been one of riding out the storm, holding your long term positions.

It is this latter group that should pay attention here. At some point the market will bottom and start to move back higher. Their portfolios will start to rise again and recover. They can sit back and watch this happen, or they can look to add a little spice to their portfolio with a stock repair strategy. This strategy uses options alongside your stocks to speed up the recovery.

Let’s use Costco, $COST, as an example to illustrate the strategy. Costco bottomed at $307 in March of 2020. But if you were a long term investor entering the stock after the Great Financial Crisis your cost basis might be under $100. That investor might be lamenting the drop from over $600 to the current price just under $500, but not so concerned about the prospects as to want to sell the stock.

With the price finding a bottom near $400 in May and now moving higher it is possible the worst is over. The price had retraced 61.8% of the post pandemic move higher when it found support and momentum gauges bottomed. Now price and momentum are picking up. Savvy investors can take advantage of that reversal by using the stock repair strategy.

The strategy is to buy 1 call options and then sell two higher strike call options, for every 100 shares of the stock you own. The goal is to have the net cost of the 3 options to be zero or give you a credit. The result after it is implemented is you have a call spread, and stock with a covered call sold against it. Should the price rise you see appreciation in both the stock price and in the call spread. This gets capped at the strike price of the short options, so a fast move higher could end up with double appreciation but your stock called away. The downside risk is that the options expire worthless.

Using the chart above let’s create a real life example. At $491 the price is breaking resistance, confirming a reversal higher. There is prior resistance at 530 and 565. The company reports its earnings next in late September. Looking at the October options chain, the 560 strike calls, nearly 14% above the current stock price, can be sold for $8.20. An August 500/520 call spread can be purchased for $8.05. By combining the short October call and the long August call spread, you can obtain magnified performance if the stock continues higher into August expiry, while still retaining the possibility of further upside into October, all for no cost.

The performance graphic shows the value of the stock compared to the value of the combined stock and repair strategy, for a given stock price at August expiration. The repair strategy adds $1 per $1 move in the stock price for a range from $500, the lower strike of the call spread, to $520, the upper strike, enhancing the return for that range. Notice that there is no point where the stock repair performance is below the straight stock performance.

This is just one example. The options can all be from the same expiry or have a longer tail as above. The key is to get the cost below zero and keep the highest strike sold call at a price where you would be comfortable if your stock gets called away there. Now take a look through your portfolio and try out this strategy.

If you like what you see above sign up for deeper analysis and trading strategy by using the Get Premium button above. As always you can see details of individual charts and more on my StockTwits page.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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