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During a recession, the country’s Gross Domestic Product (GDP) typically drops for two or more consecutive quarters. As a result, the overall state of affairs during that time is not ideal for making investments.
Right now, the market expects a recession around the horizon and typically gets more volatile during a downturn. Investors with low to medium-risk appetites who are more sensitive to market contractions should look at a shorter investment horizon.
Intelligent options trading investors can and will adjust their options strategies to adapt to the changing market conditions. Several options strategies can provide a protective shield to the investors and help them sail through the recessionary market phase with ease. These options strategies help minimize downside risk and maximize the potential for traders to remain profitable.
Options Strategies For A Recession
4 Best Options Strategies You Can Deploy During A Recession
Let’s discuss some of the best option strategies an option trader can use if the economy dips into a recession.
1. Covered Calls
During a recession, there is a significant increase in implied volatility in the market, which raises option premiums. As a result, the Covered Call strategy is an excellent call strategy to deal with volatility. The options trader who sells call options must own an equal number of underlying securities under this strategy. To execute this strategy, an investor with a long position in an asset must write a call option on the asset to generate income in the form of an options premium. By writing the call option, the buyer gains the right to purchase the underlying shares at a specified price and time. Covered calls means that you are bullish on a particular stock or ETFs.
Options contracts are typically subject to an infinite or maximum risk. However, Covered Calls are one of the safest strategies because the magnitude of losses is relatively low. Even in the worst-case scenario, such as selling off the shares owned or the shares losing value to the point where it drops below the amount of premium earned, the investor’s potential loss is limited. Besides, suppose the buyer of the options does not exercise his call option until it expires. In that case, the seller can continue selling covered calls against the same shares and receive an additional premium.
2. Married Put
A Married Put is another helpful option strategy in periods of economic downturns. Many investors choose it to protect their downside risk while holding a stock. Also known as Protective Put, this strategy is an insurance contract that establishes a price floor and helps in cases of a sharp fall in the price of underlying assets. In this, the investor purchases the underlying asset, say shares of a stock, and also purchases put options for equal numbers of shares. After that, the put option holder gets the right to sell that stock at the strike price.
Married Put works well in times of high market volatility, so opting for it might be fruitful in times of recession when volatility levels are incredibly high. Moreover, the best thing is, by executing this strategy, even in the worst-case scenarios, the loss of the investors usually gets limited to a small amount only. At the same time, one can also participate in the price gains if there is a price appreciation. However, the overall cost is comparatively higher because Put options premiums are usually significantly high. So, the repetitive use of this strategy might not suit the financial goals of many investors.
3. Bearish Call Spread
The Bearish Call Spread strategy consists of two parts: Selling a call option and collecting an upfront option premium from it, followed by purchasing a second call option with a similar expiration date but at a higher strike price. Here the premium collected on the first leg is always more significant than the premium collected on the second leg. As a result, this strategy generally generates premium income in every market situation. Besides, premiums are collected based on how bearish the investor is about the underlying asset.
A Bearish Call Spread is usually used when a modest downside in the market is expected or the implied volatility levels increase. So, it can be perfect in times of recession. The strategy serves as a risk mitigation mechanism, although it limits the maximum gain to the amount of net premium collected. Further, in the case of short selling, the maximum profit is limited to the difference between the price at which the short sale was affected and the theoretical low to which a stock can decline, i.e., zero.
4. Protective Collar
A Protective Collar strategy usually protects the capital against significant losses. It involves three steps, i.e., taking a long position in the underlying asset, purchasing a Put option to hedge the downside risk on the underlying, and writing a call option on the underlying to finance the purchase of the put. Moreover, both the put and call should be OTM options with similar expiry dates. This strategy is called so because the put position provides the downside protection of the underlying until its expiry.
The Protective Collar strategy can be a great fit during times of recession when market volatility is exceptionally high, and a market downturn occurs or is expected. It acts as a shield against short-term downside movements in a cost-effective manner protecting the investors against losses while also allowing them to make money. However, rather than profits, this strategy is mainly used for hedging as it limits the level of gains one can make. Moreover, the investors are also required to give away the opportunity of gaining from any upward movement that might take place.
While trading options during a recession, it is best to avoid maximum risk strategies as options contracts can expire worthless. Either of the options strategy in this article follow the same logic, and you can make a decent-sized profit if you execute them well.
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