One of the premier uses of options is a repair strategy or a remedy.
This is a textbook setup and it won't always be this clean.
Account needs to options suitable and it may incur any out of the pocket expense.
It can be done with equity options, index and futures options, and ETF/ETN options.
Margining and the no out pocket becomes an issue in some circumstances.
Prior to the break last week you owned a 1000 Gizmo with basis of $60.
Gizmo is now trading a fifty and your down $10,000 -
You can:
Buy More - sucks worse if it continues the decline and takes some $$.
Write a covered call and lower your basis.
Write a put and lower your basis.
Do the repair - buy 10 of the '50s at 2X and sell 20 of the 60's at 1X.
Textbook numbers. Nothing is uncovered. Costs nothing and drops my breakeven to 55.
Is it always this clean? Of course not.
Can I do it with an index option on an entire portfolio to lower the portfolio B/E - sure but there are margin and correlation issues. Same with futures option, but it's hell of an idea if your portfolio has gone in the toilet.
My stock isn't optionable - it may not be possible, but before you give up look at ETF/ETN that covers the same industry.
I'm in a margin call and I can't open any new position - minimum margin is a clear indicator of minimum intelligence.
What expiration - up to you remember if it doesn't work it doesn't hurt much, but you didn't stop the bleeding.
I've done the math and I can only afford to repair 75% of my loss. Hedges and repairs don't need to have a 100% correlation.
