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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?

Chris W. Rea
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Ray K
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2 Answers2

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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.

Ellie K
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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.

JoeTaxpayer
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