Using Options to Repair a Portfolio

Let's look at UTStarcom's option chain and see how this strategy can be applied in practice. With shares trading at $17.50, one can buy the January $17.50/$22.50 one-by-two call spread for a net debit of 70 cents. The $17.50 call is trading $1.70 per contract and the $22.50 call is 50 cents, hence, $1.70 by $1 for the 70-cent net debit. It would be nice if it was a little cheaper, but it still offers a good risk/reward and will help recoup your losses quicker and with a smaller move than simply holding the stock.

For example, assume you own 1,000 shares of UTSI from $33 -- the position would be showing a $15,500 loss. If you buy the above call spread 10x20, you will be risking an additional $700, or 4% to the existing position. The maximum loss of option position is its cost of $700, which is incurred if the stock closes below $17.50 at the January expiration. The long 1,000-share stock position still carries $17,500 of risk should the stock go down to zero.

If UTSI trades above $22.50 by January, you will have recovered $9,700-$5,000 from the original 1,000 shares and $4,300, or an additional 86%, on the option position. If UTSI is above $22.50 by or before the January expiration, you can roll the position up and repeat the process using the March $22.20/$27.50 call spread.

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