Trading in futures and options can help dealers crack the nut of limitless opportunity. While option trading leads people into thinking over various bullish strategies, bearish option strategies are important when markets go down.
The beauty of trading with options lies in their versatility, which allows the trader to take best advantage of market movement in any direction. Also, options can be structured into financial hybrids that define the action or create crossbreed strategies in bear markets.
Obviously, you may not jump into trading and investing in derivatives when you first open a Demat account. Yet, it may be worth your time. For instance, if you expect the market to go down, you can always make money when prices decline by using bearish option strategies. These strategies range from moderately bearish, and plain bearish to harshly bearish, and you can always pick the best among them depending on your market stance and risk appetite.
The Best Bearish Option Strategies
1. The Bear Call Spread
This is a very simple yet productive bearish option position. The Bear Call Spread entails selling a call at a lower strike price `and buying another call at a higher strike price, all for the same expiry date and underlying stock. The strategy is initiated by a dealer if the expected outcome is a moderate decrease in the price of the underlying asset.
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Example:
Suppose a stock is trading at ₹ 1,000. You believe that this stock will go down but not dramatically. You can do a Bear Call Spread as follows:
Sell a Call Option: Write a call option with one month left, and a ₹1,000 strike price and get ₹50 premium.
Buy a Call Option: Buy a call option with one month left, and for ₹1,100 strike price, you will pay ₹20.
Net Credit: The net credit collected would be ₹50 – ₹20 = ₹30 per share. If the price of the share will not go past ₹1,000, then the whole credit is maintained as profit.
2. The Bear Put Spread
Another way traders often consider bearish strategies in a stock is through a Bear Put Spread. This spread consists of the purchase of a higher strike, or in the money put, and the sale of a lower strike, or out of the money put with the same expiration date and underlying asset. The trader’s perspective in the Bear Put Spread centers around the idea that the underprice will have a moderate decline.
Example:
Suppose a stock is trading at ₹1,000. You think the stock is going to go down. You construct a Bear Put Spread by:
Buy a Put Option: Buy a put option with a strike price of ₹1,000, expiring in one month, which costs ₹50.
Sell a Put Option: To partially finance the above investment, sell a put option with a strike price of ₹900, expiring in one month, which earns ₹20.
Net to the Cost: The whole spread would cost ₹50 – ₹20 = ₹30 per share. If the price of the stock collapses to ₹900 or lower, your maximum profit will be capped at ₹70 per share (₹1,000 – ₹900 – ₹30).
3. The Synthetic Put
The Synthetic Put is a bearish strategy and, therefore, it mimics a long put option. This, in turn, involves holding a short position in the stock but buying the call option on the same stock. This strategy is then used to protect against rising prices.
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Example:
Let us say that you have a short position in a stock that is currently trading at ₹1,000. You would have liked to short the stock using a Put option, but you have to pay a high premium. You can, therefore, construct a Synthetic Put as follows:
Sell Short the Stock: Sell 100 shares at ₹1,000 each.
Buy a Call Option: Buy a ₹1,000 strike price call with one month to expiration for a price of ₹30 per share.
Cost: ₹3,000 premium. This strategy is capping the risk at the ₹1,000 strike but, theoretically, it has no upside limit with respect to maximum profit.
4. Strip Strategy
The Strip Strategy is considered to be a variation of the Long Straddle strategy that is found to have a bearish bias. In this strategy, two Put options and one call option with same strike price and same expiry date are bought. This works in those markets which are expected to show high volatility with little bearish bias.
Example:
Stock is trading at ₹ 1,000. You expect a spike in volatility with some bearish bias. You can create a Strip Strategy by :
Selling two puts: In this instance, purchase two puts options at the strike price ₹1,000 one month expiring at ₹50 each.
Buying one call: In this case, buy one call option at the strike price ₹1,000, one month expiring, at ₹30.
Net Cost: The net cost will be ₹50+ ₹50+ ₹30= ₹130 a share. There lies unlimited profit potential just in case the stock price nose-dives.
5. Bear Butterfly Spread
The Bear Butterfly Spread is a rather complex strategy involving three strike prices: selling two call options at the middle strike price, buying one call option at a lower strike price, and buying one call option at a higher strike price. All of these options will have the same expiration date.
Example:
Suppose a stock is trading at ₹1,000. You’ve formed the view that it’s going to fall but won’t fall below a certain level. Now, you can implement a Bear Butterfly Spread in the following manner.
Buy Call Option: Buy one call option of strike price ₹900, expiring in one month, for ₹20.
Sell Two Call Options: Sell two call options of ₹1,000 strike price, expiring in one month, for ₹50 apiece.
Buying a Call Option: Buy one call option, having an exercise price of ₹1,100, expiring in a month for ₹10.
Net Cost: So, the net cost would be ₹20– ₹50 – ₹50 + ₹10 = ₹30 per share. Obviously, the maximum profit occurs when the stock is available at ₹1,000 at expiry and the maximum loss would be restricted to the net premium paid.
Conclusion
The following bearish option trading strategies can be understood and implemented to give traders a better understanding of how to navigate falling markets. Any trader, by appropriate strategy selection according to his requirement on market outlook and risk tolerance, can gain substantially in a bearish market.
Be it for a novice or a professional trader, these strategies would prove to be valuable in not only managing losses but also deriving profits from the downturn of the markets.
