Repair Strategy. Good Idea or an Illusion?

The idea of a repair strategy is attractive to investors.  And in a bear market, there are many positions that are candidates for repair.  Because a prominent financial publication recently promoted the idea of using a repair strategy, I decided to comment.

Adam (Daily Options Report) correctly takes issue with 'repair strategy' advice offered by a guest columnist for The Striking Price that appears in Barron's.  The guest columnist says: "This is a technique that allows us to do more with less, and to be constructive with available cash." 

Maybe, but I believe it's better to take that cash and find a new, better trade.

The idea behind the repair strategy is to take a losing stock position and give yourself an improved chance (compared with simply holding the stock) to return to break even. 

If you're interested in learning the details of such a strategy, the CBOE provides a good description.


Repair Strategy: Who can use it?

  • An investor who owns stock bought above the current price -   and whose primary objective is to break-even on the trade.

  • An investor willing to sacrifice the chance to earn a profit, in return for having an increased chance to get back to break-even.

Discussion

Let me get to the main point:  I am not a fan of the repair strategy.  Why?  Although it feels great to turn a loser into a non-loser, 'feeling great' is not your trading objective.  Making money is your objective.  To me, the repair strategy is fine – as long as you want to remain invested in this position and believe it gives you an excellent opportunity to earn a profit – starting today.  The past is history.

What does the repair strategy attempt to accomplish?  Answer: To earn enough money from the new trade to neutralize the loss.  It's a better idea than refusing to exit the trade and hoping the stock recovers to its previous level.  As I've discussed previously, 'hope' is not a viable strategy.

Psychologically, investors hate to take a loss.  It feels so much better when you have as many winning trades (and thus, as few losing trades) as possible.  After all, if you take a loss, you probably believe you made a trading mistake.  Get over it.  Losses are part of the trading business and not all losses are mistakes.

One problem with attempting the repair
is that it keeps you tied to a stock that has not performed as expected.  The investor feels the stock 'owes' him/her a profit, and thus, refuses to exit a bad trade.  

I often see a similar idea in the options world. Option traders frequently roll a position (close current position and open another – usually with strike prices that are further OTM and with a more distant expiration date) in an attempt to recover a loss.  This is an example of an investor preferring an attempt to break-even, rather than accepting a loss.  By rolling, there's the chance that the new trade will make enough to recover the current loss. There are times to roll, but trading when the goal is to recover from a loss is not one of them.  Roll when you like the new position and want to own it.

Instead of putting time, money, and effort into trying to 'repair' a
broken stock or option trade, wouldn't it be better to invest in a position that you believe has a better
change of making money – starting now?  Does it really matter which stock provides an income stream? 

You may not agree, but here's what I know to be true:

  • As an investor, your goal is to make money without taking more risk than your comfort zone can handle.  That does not mean stretching the limits of that CZ.  It does suggest finding a reduced risk strategy when possible.
  • It does not matter which stock or index provides that income.
  • It does not matter which specific strategy provides that income.  Be flexible and recognize that different market conditions require different methods.

Conclusion

Examine your portfolio.  Make these decisions frequently:  at today's price (please ignore the price of the original trade), do you want to continue to own this position?  It the risk acceptable?  Is there enough reward potential?  What are the chances of earning vs. losing money going forward?  Would you have a better portfolio if you exited this trade and found another?

Please don't feel that you cannot take a loss.  Option traders lose money with a portion of their trades.  That's inevitable.  Your goal is to make good money over the longer term, and to do a good job managing risk.

141

 

2 Responses to Repair Strategy. Good Idea or an Illusion?

  1. dave 10/19/2008 at 2:20 PM #

    I have to say I completely agree with you here Mark. I feel very strongly about being married to bad positions. In the time it takes to figure out how to manage or how you will exit a bad position you could have added 3-5 good new profitable positions that more than make up the loss. I have even exited positions with small profits that i had put on the previous day because over night i evaluted the risk reward and even though it may have been profitable it wasn’t worth additional risk. Whenver I have stayed with a losing position it has clouded my judgement and been a distraction. Even though cutting those positions stings it is a lot better than the anguish and distraction of watching your position go deeper in the hole.

  2. Mark 10/19/2008 at 11:20 PM #

    Dave,
    Thanks for the comment. That describes what often occurs when an investor becomes emotionally attached to a position – and cannot take a loss.
    To be a long-term winner, it’s important to overcome that attachment.
    Mark