Yesterday (September 26), Bed Bath & Beyond (NasdaqGS: BBBY) released Q2 results that came in well below expectations. The company reported EPS (earnings per share) of 36 cents compared to the analysts’ consensus estimate of 50 cents. Although total revenue was flat, same-store sales fell while analysts were predicting a slight increase.

No matter how you slice it, it was an ugly quarter that calls into question the competency (and job security) of the company’s senior management team. Its share price dropped below $15 this morning on more than ten times its average daily volume.

That’s bad news since BBBY was put to us last month at a strike price of $20.

Okay, so we have a situation somewhat reminiscent of what happened with Spectra Energy Partners (NYSE: SEP) earlier this year. In that case, we eventually made money on SEP by waiting for its share price to recover and then writing a covered call against it.

In this case, I don’t believe BBBY will recover as quickly as SEP did so waiting for its share price to get back up into the upper-teens could tie up capital in this trade longer than some would like. For those investors, I am suggesting a different course of action to consider that would effectively roll this trade down to a lower strike price so they may exit the position earlier.

To be clear, the strategy I am suggesting is not without risk. There’s a chance you may end up owning more shares of BBBY, so if you’d rather ride it out and wait for the stock to recover then you can ignore the rest of this article.

What I suggest below is not an official trade recommendation so it will not be tracked in the Income Millionaire portfolio table. It is intended as a suggestion for investors who had shares of BBBY put them last month and would like an alternative strategy to consider.

Since I’m the guy that recommended selling the put on BBBY in the first place, I feel I owe it to you to suggest a way of getting out of it at minimal loss.

Here’s how it works.

First, I suggest selling a new short put against BBBY at the $15 strike price that expires on January 18 for a minimum premium of $1.50 ($150 per contract). If this contract ends up being assigned to you, the option premium received reduces your effective cost basis to $13.50.

When we first sold a short put on BBBY in June, we recommended a minimum premium of $1.25 for a $20 strike price. That reduced our cost basis in the shares we currently own to $18.75.

As I see it, there are three categories of potential outcomes that will dictate how well this trade works out.

SCENARIO 1 – BBBY does not rise above $15 by the January 18 expiration date

If the new short put trade expires in-the-money and is exercised against you, then the average cost basis for the two contracts works out to $16.125 [=(18.75+13.50)/2].

It is considerably more likely that you will be able to write a profitable covered call against the combined position at a cost basis of $16.125 than at $18.75.

It is impossible to judge precisely where BBBY will bottom out, but given how heavy (and one-sided) the trading volume is today it is likely that the stock will recover a bit once the initial wave of sell orders have been executed.

After that, I expect the stock to trade flat until results from the holiday shopping season are reported in late November.

SCENARIO 2 – BBBY does rise above $15 by the January 18 expiration date

If Bed Bath & Beyond reports decent holiday sales and its share price rallies above $15 prior to our January expiration, then this put will expire out-of-the-money meaning we don’t have to buy the stock.

In that case, the $1.25 premium we received reduces our effective cost basis in the original position to $17.25 [=18.75-1.50].

Since under this scenario BBBY has already rallied above $15 and presumably has some upward momentum behind it, we should not have to wait long before we can write a profitable covered call against it.

SCENARIO 3 – BBBY does not rise above $15 by the January 18 expiration date and continues to fall

Of course, the biggest risk to this strategy is that Bed Bath & Beyond goes the way of Sears Holdings (NasdaqGS: SHLD) and never recovers. If that happens, then reducing our cost basis won’t help much. Obviously, if I thought that was likely to occur then I’d suggest simply selling your shares of BBBY now and eating the loss.

The good news is Bed Bath & Beyond generates strong cash flow so it has the means to take corrective action. Also, its debt/equity ratio is sustainable so it is not a near-term risk of coming under the control of its creditors.

If anything, the fact that BBBY is now trading well below its book value may entice an activist investor to step in and restructure the company. In that case, we may be able to write a profitable covered call against this position sooner than expected.