5

If I bought some short-term call options on an expectation that the underlying stock would go up, but instead the underlying stock declined some, shortly after my options purchase, what choices are available to me?

Should I just "chalk it up as a loss/mistake", and simply hope to "get lucky" on the underlying stock rising again before the options expire (worthless)?

Or, could I take some other "recovery" strategy? What are possible recovery strategies to consider in such a situation, and what are the risks for each?

  • 2
    I've edited and re-opened this question that the community had voted to close. I think there's an interesting question in here, but it was lost in off-topic/too-localized specifics of a particular trade. I hope you'll agree my edits to generalize make this a viable question for the site? – Chris W. Rea Oct 3 '11 at 14:45
  • I think general questions are good, and helpful. I also think, giving a specific example to be used can be beneficial, to highlight/clarify the general answer. – Ray K Oct 3 '11 at 22:34
  • @RayK Yes, and no. Generally, we don't want to provide buy/sell advice on specific securities -- or the site would degenerate into a stock discussion forum. (There are enough of those!) Buy/sell advice on specific securities is off-topic. If you want to use an example, talk about a fictitious stock/company ... "XYZ Co.", for instance. Questions about specific companies are permitted (e.g. to help one understand financials), just not in a buy/sell/what-should-I-do context. – Chris W. Rea Oct 4 '11 at 4:02
  • If you think the underlying price will increase, but not before the call expiration date, try a forward calendar spread: buy calls with longer expiration dates and simultaneously sell your current calls. Be sure to do this as a single transaction (cboe.com/cob/cob.aspx). You'll pay to do this, but it gives your underlying more time to perform. – barrycarter Oct 10 '11 at 3:03
5

For personal investing, and speculative/ highly risky securities ("wasting assets", which is exactly what options are), it is better to think in terms of sunk costs. Don't chase this trade, trying to make your money back. You should minimize your loss. Unwind the position now, while there is still some remaining value in those call options, and take a short-term loss.

Or, you could try this.

Let's say you own an exchange traded call option on a listed stock (very general case). I don't know how much time remains before the option's expiration date. Be that as it may, I could suggest this to effect a "recovery".

  • Don't sell your call options, AND,
  • If available in sufficient quantity, borrow and sell the underlying security that the call option was written on (short sell it).

You'll be long the call and short the stock. This is called a delta hedge, as you would be delta trading the stock. Delta refers to short-term price volatility.

In other words, you'll short a single large block of the stock, then buy shares, in small increments, whenever the market drops slightly, on an intra-day basis. When the market price of the stock rises incrementally, you'll sell a few shares. Back and forth, in response to short-term market price moves, while maintaining a static "hedge ratio". As your original call option gets closer to maturity, roll it over into the next available contract, either one-month, or preferably three-month, time to expiration.

If you don't want to, or can't, borrow the underlying stock to short, you could do a synthetic short. A synthetic short is a combination of a long put and a short call, whose pay-off replicates the short stock payoff.

I personally would never purchase an unhedged option or warrant. But since that is what you own right now, you have two choices: Get out, or dig in deeper, with the realization that you are doing a lot of work just to trade your way back to a net zero P&L.

*While you can make a profit using this sort of strategy, I'm not certain if that is within the scope of the money.stachexchange.com website.

  • 2
    Feral, thanks for the delta hedge and synthetic short explanations. – Ray K Oct 11 '11 at 5:04
  • 1
    Oh, per your statment, "I personally would never purchase an unhedged option or warrant", do you see anything "wrong" with buying a leap deep in the money (read very low time premium) on a stock one is bullish on? This seems to have several advantages to me, i.e. leverage or lower cost, and safer if the stock drops all the way down to the price of the option vs owning the stock outright, as one will then be able to collect fairly significant time premium by selling the leap (and have a lower loss than owning the stock outright). – Ray K Oct 11 '11 at 5:08
  • @RayK LEAP's aren't "wrong" to buy, especially deep in the money, for a short time horizon. But there's risk in your other scenarios: If stock price drops to 0, the option loses value faster. Also, LEAPs cost more than 1- or 3-month call options, and must be figured in. The REAL reason for statement was motivated by event while at my 1st job. I bought long-dated equity warrants, like LEAPs, in a big German company just after reunification. My calls expired prior to Germany's recovery, which took longer than anticipated. I lost 100% of the call premium. Should have sold, but didn't. – Ellie Kesselman Oct 12 '11 at 14:36
2

The nature of options requires you to understand that they are essentially a bet. In one sense, so is investing in stocks. We imagine a bell curve (first mistake) with a median return at 10%/yr and a standard deviation of about 14%. Then we say that odds are that over some period of time a monte-carlo simulation can give us the picture of the likely returns. Now, when you buy short term options, say one month or so, you are hoping the outcome is a rise in price that will yield some pretty high return, right?

There was a time I noticed a particular stock would move a large percent based on earnings. And earnings were a day before options expiration. So I'd buy the call that was just out of the money and if the surprise was up, I'd make 3-4X my money. But I was always prepared to lose it all and often did. I never called this investing.

I know of no recovery strategy. Sorry.

  • Agreed, I wouldn't call this investing either. It is trading, and all speculation. You are so correct. – Ellie Kesselman Oct 7 '11 at 10:49

Not the answer you're looking for? Browse other questions tagged or ask your own question.