FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.

posted on 05 May 2016

Options Strategies For When What Goes Up Comes Down

by Russ Allen, Online Trading Academy Instructor

Online Trading Academy Article of the Week

You can use put and call options in several different modes, depending on your market outlook. You can use an option trade that will make money from a rising market, if that is what you expect. If you think the market will be flat, you can choose a strategy that will profit from a lack of movement in either direction. And, if you think a down market is coming, you can take a trade that will make money if that happens.

If you are bearish, of course there are various non-option strategies that could be used to profit from a market drop:

  • You could sell short individual stocks, or exchange-traded funds (ETFs) that represent stocks. If the market drop did materialize, you could then close out those trades at a profit by buying back the short position at a lower price.

  • For more leverage, you could sell futures contracts on the stock indexes instead of stocks or ETFs. The futures contracts, being leveraged at 20 to 1 or more, will show a much bigger profit if the drop does occur.

  • You could buy inverse ETFs which go up in price when the market goes down.

Those are powerful strategies and often one of them will be the best choice, but buying put options is another simple bearish alternative with some unique properties. When done properly, and at the right time, this can pay off very well.

Below is a weekly chart of SPY, the ETF that tracks the S&P 500 index as of April 27, 2016.

Options trading strategies for a bear market

Notice that SPY was approaching the highs near $215 that it first made in June of 2015 and retested in November-December 2015. Could the third time be the charm? Or would SPY drop 15% from here as it had the last two times?

The participants in the options market were not expecting a big drop. We know this because options were going for very cheap prices. The indicator at the bottom of the chart shows a measure of the relative expensiveness of options. It was extremely low. This indicates that people who were selling and buying options did not believe that there would be much price movement in the near future. The market was very complacent, which is usually the case before a meltdown.

There is of course the chance that their complacency could be well-founded. Maybe nothing bad will ever happen again.

If you weren't so sure about that, you could use options to make a trade pretty cheaply that would profit from a big drop in price. And in this situation of extremely cheap options, it could be better than the bearish alternatives mentioned above.

The $200 strike August puts, for example, were available for about $475 per contract. This bearish trade would pay off in a big way if SPY dropped hard. And:

  • Unlike a short stock, short ETF position or short futures position, the option position's loss would be strictly limited in case the market went the "wrong" way (up). The very maximum loss per option contract would be the $475 paid, even if the market should skyrocket over a weekend where stops in the other markets would not be effective.

  • Compared to an inverse ETF position or a short ETF position, the option could be bought for very little money out of pocket - $475 per 100 shares vs. more than $20,000 per hundred shares for the ETFs.

  • Options were coming from a situation where they are unloved and cheap. In a hard and fast crash, the sudden demand for the put options by those scrambling to buy them as insurance would likely cause them to gain in price at a rapidly accelerating rate, vs. a linear rate for the other choices.

It is true that the option position would lose money if in fact SPY did not drop in price by a fairly big amount, but for some traders the trade-off would be a good one. If you haven't thought about options as a simple bearish trade, you owe it to yourself to investigate the idea.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical Investing Post Listing

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.

You can also comment using Facebook directly using he comment block below.

Econintersect Investing


Print this page or create a PDF file of this page
Print Friendly and PDF

The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.

Take a look at what is going on inside of
Main Home
Analysis Blog
Rising Tide Does Not Lift All Ships
Comments on Feyerabend’s ‘Against Method’, Part II
News Blog
Docking A Huge Cruise Ship Is More Complicated Than You Think
New Seasonal Outlook Updates from NOAA and JAMSTEC - Let's Compare Them.
Infographic Of The Day: Driving Into A Battery Powered Future
Earthquake Risk - Location Matters
Investor Alert: Be On The Lookout For Investment Scams Related To Hurricane Matthew
Lost In Translation: Five Common English Phrases You May Be Using Incorrectly
The Size And Scope Of Samsung's Business
Immigration Is The Top Worry For Britons
People Killed By Russian Airstrikes In Syria
Have You Taken These 4 Simple Steps To Improve Your Trading?
14 October 2016: ECRI's WLI Growth Index Insignificantly Declines
Mom Breaks Down In Tears When Son With Autism Meets Service Dog
Rail Week Ending 15 October 2016 Paints A Negative Economic View
Investing Blog
FinTech Is Taking A Bite Out Of Banks
Options Early Assignment - Should You Worry?
Opinion Blog
US 2016 Election: Will US-China Relations Change
Prop. 51 Versus A State-Owned Bank: How California Can Save $10 Billion On A $9 Billion Loan
Precious Metals Blog
How Will The Election Outcome Impact Precious Metals?
Live Markets
21Oct2016 Market Close: Major US Indexes Close Flat On Low Volume, Crude Prices Resume Climb, US Dollar Stabilizes In Mid 98 Handle, Yes, Most Investors Are Worried Which Way This Market Will Go
Amazon Books & More

.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Middle East / Africa
USA Government

Crowdfunding ....



Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved