Bearish Options Trading Strategies

Introduction

Bearish Options Strategies are options trading strategies that are designed to profit when a stock goes down.

For stock traders, the only way to profit when a stock goes down is by shorting the stocks itself. Shorting the stocks itself does not only offers no leverage at all but also exposes you to unlimited risk should the stock rise instead of fall and also requires a significant margin.

Bearish options strategies overcomes these issues by having more than just one way of profiting from the same drop in stock price. Some bearish options strategies not only require no margin because there is no need to short anything but also has limited risk should the stock go up instead. Indeed, you can get such a wide variety of ways to profit when a stock goes down only by options trading through the use of bearish options strategies.

The Main Component

The main component of most Bearish Options Strategies are put options. Put options completely revolutionized the way traders profit when a stock goes down because there is no need to short anything at all. Traditionally, profiting when a stock goes down only happens when you short the stock itself. Shorting a stock means to "sell" something you do not yet own (through borrowing from your broker actually) and hoping to buy it back when the price drops later, resulting in a profit. This approach is unfavorable in many ways and one of these is the fact that you have to short something (the stock in this case). Having to go short places a margin requirement on your account which actually puts you in debt to the broker and exposes you to unlimited liability of returning the same number of stocks to your broker no matter what the price is in future. This is also why so few stock traders are short sellers. Short selling is simply not as convenient as buying for more retail investors. However, options trading opened up a totally new door as put options are the only financial instrument you can buy that will gain in value when a stock goes down. Yes, put options are contracts that you actually buy to own and then profit when the stock goes down. If the stock goes up instead, the put options simply expire worthless and you lose nothing more than the money paid on those put options. This limited loss potential along with the leverage put options offers is the reason why put options are the backbone of bearish options strategies.

Debit & Credit

There are two broad categories of Bearish Options Strategies; Debit Strategies and Credit Strategies. Debit Bearish Options Strategies are bearish options strategies which you need to pay cash for. These are Bearish Options Strategies that may have incorporated short options but does not cover the premium paid for the long options entirely. Credit Bearish Options Strategies are Bearish Options Strategies that credits your account with cash when the position is put on. These are Bearish Options Strategies that are made commonly by shorting call options instead of buying put options in order to profit from time decay as well. An example of credit bearish options trading strategy is the Bear Call Spread where Call options are used instead of put options. Credit Bearish Options Strategies certainly increases the odds of winning since it puts time decay in your favor but it limits the maximum options trading profit that can be made.

Lowering Initial Outlay

One main reason for the development of Bearish Options Strategies is the need to lower capital outlay when buying put options. The lower one pays for a put option position, the higher the ROI one makes from the same move, right? Bearish Options Strategies does that primarily by shorting or writing out of the money put options on top of buying the at the money or in the money put options. As long as the stock does not move lower than the strike price of the out of the money Put options, the premium earned from selling those put options partially offset the higher cost of the at the money or in the money put options, lowering the initial capital outlay of the position. An example of this is the Bear Put Spread.

Profiting From Time Decay

Bearish Options Strategies are not only capable of producing a profit only when the underlying stock goes down but also when the underlying stock remains stagnant through time decay. Bearish Options Strategies put time decay in your favor through the use of short call options instead of long put options. Short call options profit as long as the underlying stock closes lower than its strike price during expiration but has a limited profit and unlimited risk potential. The most direct example of such a bearish options trading strategy is obviously the Naked Call Write options trading strategy. The problem with such Bearish Options Strategies is the high margin deposit requirement of most options trading brokers and that is why other options are also combined with short call options to produce credit Bearish Options Strategies with lower margin requirements.

The Trade-off

Options trading is all about trade-offs. Utilizing Bearish Options Strategies rather than simply buying put options normally limits the maximum profit that you can make when the underlying stock goes down dramatically. This is the price you pay for having all the other benefits that these more complex Bearish Options Strategies grant.

Some of the Options Trading Strategies

  1. Buying Puts
Buying puts is a bearish, somewhat speculative technique in which the investor anticipates that a stock will decrease in price during a set period of time. The trader realizes a profit when the stock and its underlying put option decrease in price during a set amount of time. The profit potential in such a deal is limited because a stock price can never go below zero. Also known by the term “buying in-the-money puts”, this technique is speculative; if the price of the stock remains steady or rises during the option period, it is possible for the trader to lose the initial investment. This risk reward ratios, however, are limited to the amount paid for the premium on the put option.

The technique of buying puts is dependent on timing and charting a stock’s movement to catch a downward price movement. Accurate charting of a stock and technical analysis of its performance and direction are critical when buying puts. There are a variety of events that can move the price of a stock down as desired, such as poor earnings reports, buyout or acquisition of the company, and new product introduction are among the events that can shape the views of investors and impact the stock market. This strategy of buying puts can also put more money in the pockets of successful traders.

The downside of this technique tends to be the possibility of an error of judgment. If an investor decides to buy puts on a stock without properly researching its position or charting its movement, it is possible that stock will be bullish or changing from bearish to bullish. In essence, if a stock reached its bottom or is rising, the trader has moved at the wrong time and is in danger of losing the premium for the trade. Investing mistakes such as this are a prime example of what can go wrong when buying puts.

Buying puts is actually an alternative to selling short on a stock. While being similar to buying calls, the advantage of buying puts over selling short lies in the ability to leverage the transaction and make your trading more successful. Since the puts can be purchased on the margin, it is possible to control a much larger number of shares, thereby increasing the profit potential on the purchase. Downward movements in stock prices and their underlying put options create much larger returns than by simply selling short.

The price of a premium for buying puts is affected by two variables. First, the time period involved for the option is a determining factor in price. The longer the time between purchase and expiration dates, the higher the price. Second, the movement of the underlying stock affects the price of the premium, especially in relation to the stock’s strike price. A stock that has been in a bearish trend will have a higher premium than a stock in a bullish trend. This is a stock market basic that can be successful even for a beginner investing in the stock market.

Buying puts is one of the stock option trading strategies that provides the investor with the opportunity to make money on a stock expected to be bullish. Remembering to follow a proven stock market trading system will help deter the trader from moving on the wrong stock.

  1. Selling Calls
When an investor is feeling bearish on the market, another good stock option trading strategy to employ is Selling Calls or Selling Bear Calls. This method is also known by the name Vertical Bear Calls. This is considered a bearish strategy because the trader profits if the underlying stock decreases in value. Basically, the strategy is to buy out-of-the-money call options and sell in-the-money call options on the same stock with the same expiration date. The plan is that the in-the-money stock closes lower than its strike price at its expiration date, and then the trader realizes maximum profits from selling calls.

When selling calls, the investor will experience maximum loss when the stock price increases above the higher, out-of-the-money call option strike price at the expiration date. This loss will be the difference between the two strike prices minus the net credit of the spread when it was originated. While there is risk involved, this stock investing concept allows investors to find profits even when the market is bearish by selling calls.
The downside of selling calls is that, while it is lower risk than simply buying put options, it has a limited profit potential as well. The break-even is at the lower strike price plus net credit. The maximum profit potential is when the stock decreases below the in-the-money call option strike price. In such cases, the investor will review his / her stock trading plan to see if the data and potential risks of the strategy are likely to create successful trading when selling a call.

For example, an investor wants to sell calls on ABC, Corp. The stock price is $39.875. The trader sells an in-the-money call option with a June expiration at a strike price of $35 for $5. At the same time, the investor buys a out-of-the-money call option with a June expiration at a strike price of $40 for $1.56. Selling a call such as this is a net credit of $3.44, spread of $5, or the difference between the costs of the two options. If the stock price is lower the in-the-money strike price on the expiration date, this would be a maximum profit of the net credit when selling the calls: $5.00 - $1.56= $3.44 x 1 contract (100 shares) for a maximum profit of $344. Conversely, the maximum loss would be if the stock closed above the out-of-the-money strike price on its expiration date: $5.00 Call Spread - $3.44 net credit received = $1.56 x 1 contract for a maximum loss of $156.00. Because the risk is low, the risk reward ratios when selling calls are still very good.

A successful trader will adequately investigate such a move prior to selling calls. That way, he / she can be assured that the trade has a high probability of being successful. As with any trade, the investor needs to understand the risks and potential profits involved in order to make a wise decision. Using a stock trading system such as Japanese Candlesticks, the investor has access to charts that are understandable and powerful data in the attempt to sell calls to make a profit.

  1. Put Hedge
A Put Hedge is the stock option trading strategy of buying puts during a bearish market to protect stock shares that, while the trader is reluctant to sell, are vulnerable to a decline in the market. Successful traders utilize strategies such as Put Hedges to insulate their portfolios from loss in a bearish market. This method also has the potential of unlimited profits, while at the same time limiting the potential loss by the investor.

When a trader is utilizing portfolio diversification and feels that the portfolio is exposed to a market decline, it is possible for the investor to have several options available to create a Put Hedge. An excellent technique, if the trader feels his, or her, portfolio is sufficiently diversified, is to purchase index puts to protect the entire portfolio. To implement a Put Hedge, the investor needs to select an index that best represents his / her portfolio. If the trader has successfully utilized his / her stock trading system, such as Japanese Candlesticks, and identified a declining market, any losses incurred with the decline in assets will, in turn, be offset by the gains made as the value of the index puts, or Put Hedges, experience an increase.

In such a stock market strategy, the profit reward has the potential to be unlimited, since both the traders’ portfolio and Put Hedge could rise instead of fall. In this instance, the investor would make money on the portfolio and the index puts minus the cost of the premium paid for the puts. If the stock market technical analysis of the trader is correct and the market declines, the losses on the established portfolio will be limited because they will be offset by the gains realized on the Put Hedges that were purchased. These puts, in turn, have been successful and the investor has created a Put Hedge which protected the trader’s portfolio in a bear market.

When the market turns or the investor once again has confidence in its stability, he / she can sell the index puts if the retain any value, giving the trader another avenue of profit. If the market index puts have expired, the trader will need to determine an appropriate course of action. If the market has truly turned, the investor can simply do nothing, since he / she no longer needs a Put Hedge to protect the stock portfolio. If the market is still bearish and unstable, the trader will need to determine whether it is necessary to purchase an additional Put Hedge as protection against the stock market. If so, the method for this transaction will be identical to the original purchase.

As with any strategy in the stock market, it is important to analyze the expectations for the underlying asset and for the market before proceeding. Remembering that this practice occurs during a bearish market, the investor must realize that any strategy should be conservative and consistent with his / her stock trading plan. Whether using Put Hedges or buying out-of-the-money calls, it is important that the investor understands that the ultimate goal is to make money, as well as to protect the money already made.

  1. Bear Call Spread
A Bear Call Spread is a stock market strategy employed when the market is extremely volatile and moderately bearish. Because of the erratic movements in a bear market, an investor will, in many instances, look to make moves that are profitable, yet hold low risk. The Bear Call Spread, also known as the Bear Credit Spread, is just such a technique that successful traders use in times such as these.

The stock option trading strategy for a Bear Call Spread is as follows. A trader sells a call option at one strike price and buys a call on the same asset which is further out-of-the-money (at a higher strike price). In most cases, both options will have the same expiration date. The profit and loss strategy for a Bear Call Spread is quite similar to a Bear Put Spread; however with this technique; the trader immediately receives a net premium when establishing the position. In a Bear Put Spread, the premium is paid when the position is established. Because of this difference, the investor already has money in hand at the inception of the Bear Call Spread.

The Bear Call Spread is lower risk than the Bear Put Spread; however, the profit potential is lessened as well. In a Bear Call Spread, the risk is minimized because the investor purchases lower priced calls that are protection if the price goes up significantly. Conversely, in a Bear Call Spread, profit potential is limited to the premium collected for the calls sold, less the cost of the premium paid for the calls that were purchased. As the name implies, this strategy is used in a bearish market, unlike the Bull Call Spread, which is employed when the market has become bullish.

A Bear Call Spread is a perfect example of successful trading. When an investor, through stock market technical analysis, realizes the presence of a bear market, it is imperative to modify the stock investing system. A bull market brings more opportunities for profitable trading; a bear market typically moves a trader into a more conservative approach of minimizing risks and finding trades that, while lucrative, are less risky. A Bear Call Spread is a perfect example of such a conservative move to find profits.

During a bearish period of trading, it is necessary for the investor to follow his, or her, stock trading plan. This requires solid stock technical analysis, stop loss strategies, and utilization of a stock trading system such as Japanese Candlesticks. This system, which has more than 200 years of success, helps the investor to evaluate the data obtained through technical analysis. Japanese Candlesticks is invaluable, especially in bearish times, as it assists the trader in drawing conclusions about the movements of the market.

A Bear Call Spread is one technique that an investor can use to find profits during an especially bearish market or a market experiencing volatility. Through technical analysis tools and learning how to read stock charts, a trader can focus on making money even when the market wants to take money from its investors.

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