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In a bear market, the market keeps falling, and thus making money in a bearish market might seem challenging. However, by leveraging the power of options, one can profit from the fall and take advantage of the bearish market conditions. Investors can use the options alone or combine them with other options or futures contracts to create sophisticated hybrid options strategy that capitalize on bear markets. These option strategies can also be used to hedge against specific stocks or industries.
The sheer number of different options strategies can be mind boggling, you may have heard of terminology like covered call, long calendar spread, iron condor, credit spread, bull call spread, debit spread, bull put spread, vertical spread, or iron butterfly. A distinct set of strategies has proven to be highly effective and profitable in a bear market. So, to profit from such a market, one must use these bearish option strategies.
Best Bearish Option Strategies
6 Best Bearish Option Strategies Every Trader Should Know About
Here are six of the most effective option trading strategies every trader should know to help you on your investing journey if you are looking to trade options.
1. Bear Call Spread
A Bear call spread trading strategy is a highly suitable option strategy for a bearish market. It has two parts. The first one involves selling a call option and collecting an upfront option premium. The second one is about purchasing a second call option at a higher strike price simultaneously with the same expiry date. It is a risk-mitigation strategy in which call options are bought to protect a short position in a stock or index.
Investors can use this bearish option strategy when they believe the underlying asset price is falling moderately or the level of volatility is high and risk mitigation is required. Moreover, the maximum risk will be the difference between the strike prices and the net credit received. Further, the maximum gain will be restricted to the amount of net premium received as a call option is sold instead of a stock. The maximum loss, on the other hand, will also be limited to the difference between the spread amount and net credit.
2. Bear Put Spread
A bear put strategy, also known as a debit put spread or a long-put spread is usually implemented when a bearish investor wants to maximize profits while minimizing losses. To achieve this strategy, investors need to purchase put options and simultaneously sell the same number of puts on the same asset having the same expiry date at a lower strike price. This strategy works well in modestly declining markets, so the more the cost of the underlying security starts dropping, the more profit the option holder derives.
The primary advantage of using this bearish option strategy is that the trade’s net risk is mainly reduced to the net amount paid for the options. Moreover, selling the put option at a lower price offsets the cost of purchasing the put option with the higher strike price, lowering the overall capital outlay.
3. Bear Ratio Spread
A bear ratio spread, also known as a put ratio spread, allows traders to generate profits when the underlying asset price declines. It contains uneven numbers of short and long positions, usually in the range of 2:1, implying there’s only one long position for every two short positions. However, this ratio can also differ depending on the needs and requirements of the investors. Experienced traders usually opt for a 3:1 or a 4:1 ratio while setting up their trades.
Despite having many complications, this option strategy for a bearish market comes with increased levels of flexibility. One can write a higher amount at a ratio that suits their trading goals perfectly. Moreover, this bearish option strategy can also pull down or even eliminate the upfront costs and increase the profit-making potential when the price of the underlying falls within the forecasted levels. However, because of its high complexity, it is only suitable for experienced traders with good knowledge about options trading.
4. Bear Butterfly Spread
A bear butterfly spread strategy is a modified version of the butterfly spread that is designed to profit from securities with a bearish outlook. It consists of three major stages: Writing put options with a strike price equal to the expected price, purchasing put options with a strike price higher than the predicted price, and finally, purchasing put options with a strike price lower than the expected price. Notably, these options should have the same expiration date and strike prices as close as possible.
This bearish option strategy enjoys the advantage of a low upfront cost and can be applied using puts or calls for a comparable return. However, potential profits are limited to some extent, and often investors are left with a minimal net debit value after these transactions. Further, beginners should not opt for this strategy because of the high complexity levels.
The strip strategy can be used by an investor who is bearish on the market but bullish on volatility. It entails purchasing two ATM Put Options and one ATM Call Option with the same strike price and expiry date. As a result, the cost involved in constructing this outlay is on the higher side.
Although strip is assumed to be a market-neutral strategy, it pays off relatively more if the underlying asset’s price falls rather than rises. Maximum profit is almost unlimited in this situation, while maximum loss occurs when the underlying price reaches the Strike Price of the short Call and Put purchased. Besides that, the risk of this strategy is limited to the total amount of options premium paid.
6. Bear Put Ladder Spread
The bear put ladder spread strategy is a variation of the bear put spread strategy. It is widely used to profit from a security’s price decline and includes additional transactions to reduce the initial investment required to establish spreads. This option strategy for a bearish market is best suited when investors anticipate that the price of a security will not fall significantly, and it can result in significant losses if the downward price movement is greater than expected. Furthermore, the profit potential is limited.
Over the years, the abovementioned strategies have been widely used to profit and generate income from a bear market. An option trader can therefore choose any of them for their trades as a means of hedging against a market drop. However, before actually putting in their money, they must do their research as trading options can be a bit more risky then traditional swing trading as your calls and puts can expire and become worthless in value. Be sure to have a balanced portfolio that also has exposure to ETFs, dividend stocks and/or other low-risk equities.
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