When the market is looking bleak, bearish options strategies can help weather the storm of the stock market, explains Patrick Martin, managing editor at Schaeffer Investment Research, a leading advisory platform from options expert Bernie Schaeffer.
So, whether you are an active options trader or an investor, you can benefit from bearish options strategies. Investors can hedge their stock portfolios by selling or purchasing options to benefit from the downward market.
In comparison, options traders can simply place bearish options trades to generate income. So regardless of your stock portfolio, bearish options strategies can help you generate a profit when the market is bleak.
The Best Bearish Options Strategies
Various options strategies can be profitable in a bear market. These bearish options strategies listed below include short volatility and long volatility methods. Taking a stance on volatility is essential for all options traders because it tells you how expensive options are.
When implied volatility is high, you want to avoid buying puts because they become inflated. On the other hand, when implied volatility is low, buying puts is a great option to hedge against volatility and stock prices dropping.
Bear Put Spreads
The bear put spread is when you buy a put and sell a lower strike put in the same expiration. The put option you purchased will provide bearish exposure, while the short put will help pay for the long.
The bear put spread also benefits from a rise in volatility, so if you believe it will increase, the bull put spread is a good option. As stock prices fall, volatility tends to increase, making puts a great way to hedge against volatility expansion and bearish market sentiment.
Bear Call Spreads
A bear call spread is when you sell a call option and then purchase a call option with a higher strike price within the same expiration date. The short call provides bearish exposure, while the long call hedges your risk to the upside.
The bear call spread will benefit from a drop in volatility since you are net short options. Generally, volatility increases as the price of a stock drops, but your bear call spread will ultimately be profitable due to the decrease in the delta.
The protective put strategy is when you hedge your equity with a long put option. For example, if you think the stock market will drop, you can buy a put option to protect your risk to the downside instead of selling your shares.
Using a protective put has various benefits, including avoiding capital gains taxes from selling your stock. If you realize a gain from selling a stock, you will have to pay taxes on it in most accounts. If you buy a put instead, you get to hold your shares and potentially generate additional profit from the put.
The covered call is a great strategy to use for stock investors. If you already own shares of a company, selling a call will reduce your downside risk.
However, the covered call is an overall bullish strategy meaning you should not enter it if you think the stock market will fall. Instead, you can sell a call against shares already in your stock portfolio, adding bearish exposure.
Bearish Options Strategies: Bottom Line
If you are trading bearish options strategies, a critical factor you must watch for is the underlying implied volatility. Generally, you want to buy options when you believe volatility will rise and sell options when you think volatility will fall.
Another essential factor to consider is that if you are wrong and the market doesn’t drop, you will limit your profit to the upside. Protective puts and short calls are great when the market drops, but you will hinder your earnings if the stock market goes on a bullish rally.