What are the top 5 options trading strategies for a bear market?

As the old saying goes, “What goes up, must come down.” In the stock market, this means that the bull market will eventually give way to a bear market.

This is a time when stocks start to decline, and investors become more cautious about their investments. If you’re an options trader, a bear market can be a challenging time.

However, there are strategies you can use to navigate the market and even profit from it. In this article, we’ll discuss the top 5 options trading strategies for a bear market.

The First Options Trading Strategy: Protective Put

The protective put strategy is a popular options trading strategy that can help protect your portfolio during a bear market.

This strategy involves buying a put option for each share of stock you own. A put option gives you the right, but not the obligation, to sell a stock at a predetermined price, known as the strike price. If the stock price drops, the put option will increase in value, offsetting some of the losses from the stock. The downside to this strategy is that it comes with a cost, as you must pay for the put option.

How the protective put works: a pratical example

Suppose you own 100 shares of XYZ stock, which is currently trading at $50 per share. You are concerned that the stock may decline in a bear market, so you decide to purchase 100 put options with a strike price of $45 for $3 per option. This means you will pay a total of $300 for the put options.

If the stock price drops to $40 per share, your put option will be in the money, meaning it has intrinsic value. You can exercise your put option and sell your stock at the strike price of $45 per share, limiting your losses to $5 per share. Without the put option, you would have lost $10 per share. The profit from the put option offsets some of the losses from the stock.

On the other hand, if the stock price does not drop below the strike price of $45, your put option will expire worthless, and you will have lost the premium paid for the option. However, this loss is limited to the cost of the option, and your stock position remains intact.

The protective put strategy can also be used to protect profits in a bullish market. Suppose you own 100 shares of XYZ stock, which is currently trading at $50 per share, and you have a profit of $500. You are concerned that the stock may decline, eroding your profits, so you decide to purchase 100 put options with a strike price of $45 for $3 per option. This means you will pay a total of $300 for the put options.

If the stock price drops below $45 per share, your put option will be in the money, and you can exercise your option to sell your stock at the strike price of $45 per share, locking in your profit of $500. Without the put option, your profit would have been reduced or eliminated by the decline in the stock price.

Bear Call Spread

The bear call spread is one of the options trading strategies that can be used in a bear market. This strategy involves selling a call option with a lower strike price and buying a call option with a higher strike price, both with the same expiration date. The goal of this strategy is to profit from a decline in the stock price while limiting your potential losses.

How the bear call spread works

Suppose you own 100 shares of XYZ stock, which is currently trading at $50 per share. You are concerned that the stock may decline in a bear market, so you decide to sell a call option with a strike price of $55 for $2 per option and buy a call option with a strike price of $60 for $1 per option. This means you will receive a net credit of $1 per option or $100 for the 100 options traded.

If the stock price remains below the strike price of $55, both options will expire worthless, and you will keep the $100 premium received. If the stock price increases to $58 per share, the call option with a strike price of $55 will be in the money, meaning the buyer can exercise the option and buy the stock at the lower price of $55 per share, leaving you with a loss of $3 per share. However, the loss is limited to the difference between the strike prices minus the premium received, which is $55 – $53 or $2 per share.

If the stock price increases to $63 per share, both options will be in the money, but your loss is still limited to the difference between the strike prices minus the premium received, which is $55 – $53 or $2 per share. This is because the buyer of the call option with a strike price of $55 will exercise their option and buy the stock at $55 per share, while you exercise your option and buy the stock at $60 per share, but then sell it to the buyer at $55 per share.

Long Put Strategy

The long put strategy is one of the simplest options trading strategies that can be used in a bearish market.. This strategy involves buying a put option with the expectation that the stock price will decline, allowing you to sell the stock at a higher price than the market price.

How the long put strategy works

Suppose you own 100 shares of XYZ stock, which is currently trading at $50 per share. You are concerned that the stock may decline in a bear market, so you decide to buy a put option with a strike price of $45 for $2 per option. This means you will pay a premium of $200 for the 100 options traded.

If the stock price remains above the strike price of $45, the option will expire worthless, and you will lose the $200 premium paid. However, if the stock price declines to $40 per share, the put option will be in the money, meaning you can exercise the option and sell the stock at the higher price of $45 per share. This will result in a profit of $500, which is the difference between the market price of $40 per share and the strike price of $45 per share, minus the premium paid of $200.

If the stock price declines further to $35 per share, the put option will still be in the money, and you can sell the stock at the higher price of $45 per share. This will result in a profit of $1,000, which is the difference between the market price of $35 per share and the strike price of $45 per share, minus the premium paid of $200.

Bear Put Spread

The bear put spread is a variation of the long put strategy. This strategy involves buying a put option with a higher strike price and selling a put option with a lower strike price on the same underlying asset, with the same expiration date. This strategy limits both the potential loss and potential gain of the trade, making it a more conservative approach to profiting from a bearish market.

How the bear put spread works

Suppose you are bearish on ABC stock, which is currently trading at $50 per share. You decide to implement a bear put spread by buying a put option with a strike price of $55 for $3 per option and selling a put option with a strike price of $45 for $1 per option. You will pay a net premium of $2 per option, or $200 for 100 options traded.

If the stock price declines to $40 per share by the expiration date, the put option with a strike price of $55 will expire worthless, and the put option with a strike price of $45 will be in the money, allowing you to sell the stock at the higher price of $45 per share. This will result in a profit of $300, which is the difference between the market price of $40 per share and the strike price of $45 per share, minus the premium paid of $200.

If the stock price declines to $50 per share, the put option with a strike price of $55 will expire worthless, and the put option with a strike price of $45 will be out of the money, resulting in a loss of $200, which is the premium paid.

If the stock price declines to $60 per share, both put options will expire worthless, resulting in a loss of $200, which is the premium paid.

Naked Call options trading strategy

The short call strategy, also known as a naked call, involves selling a call option on an underlying asset that the investor does not own. This strategy is used when the investor has a bearish outlook on the underlying asset and expects the price to decrease. However, it is important to note that this strategy comes with unlimited risk and should only be used by experienced traders who understand the risks involved.

How the short call strategy works

Suppose you sell a call option on XYZ stock with a strike price of $50 for a premium of $3 per option. If the stock price declines or remains below $50, the option will expire worthless, and you keep the premium. However, if the stock price increases above $50, the option will be in the money, and you will be obligated to sell the stock at the lower strike price, resulting in a loss.

For example, if the stock price increases to $60 per share, the option will be in the money, and you will be obligated to sell the stock at the lower strike price of $50 per share, resulting in a loss of $7 per share, which is the difference between the strike price and the market price, minus the premium received of $3 per option.

As mentioned earlier, the short call strategy has unlimited risk since there is no limit to how high the stock price may rise. It is therefore essential to have a well-planned exit strategy in place to minimize potential losses. One popular approach is to buy a call option with a higher strike price to create a covered call strategy. This strategy limits the potential loss but also limits the potential gain.

Conclusion

Options trading can be a profitable way to invest in the stock market, even during a bear market. By using these top 5 options trading strategies for a bear market, you can protect your portfolio and even profit from declining stock prices.

It’s important to remember that options trading comes with risks, and it’s essential to do your research and understand the strategies before investing your money.