Bearish options strategies are used to take advantage of a downward market trend.
They help you profit from falling prices, rather than bearing the decline directly from holding stocks. Where an option does not offer a full cover, you can combine them with other options or futures in a options spread.
The following are some hybrid bearish options strategies that you can use depending on your trading circumstances:
Some Great Bearish Options Strategies:
1. Bear Call Spread
The bear call spread is a two-transactions trading strategy used when the trader expects a small to moderate price decrease in the underlying stock’s price. This position involves buying and writing a call option that has a lower strike price. The two call options should be of the same underlying asset and share an expiry date.
From selling the call option, the seller obtains a premium and from the purchase of a call premium, he collects another premium. The money got from the premiums reduces the cost of the trade significantly.
It also helps to limit the risks because the trader is entitled to the difference between the two premiums. This strategy is only ideal for when expecting a small to moderate price decline, to receive a net credit.
Typically, traders write calls that are on-the-money and purchase those that are out-of-the-money. In this way, they profit whether the underlying security price falls or stays the same.
The bear call spread strategy caps the maximum profit at the net credit while the maximum loss possible is the spread, less the net credit. The larger the spread between the strikes of the calls you write and the ones you purchase, the larger the profits.
But, the loss is significant if the underlying security price went up instead.
As such, this strategy is reasonably advanced and it requires a high knowledge of the market and options trading to manoeuvre. So, it is not suitable for beginner traders.
2. Bear Put Spread
The bear put strategy is another two-transactions trading strategy traders use to speculate on security whose price they anticipate will decrease by a small to modest range. This strategy is straightforward and suitable for beginner traders. It helps to bring down the cost of purchasing puts and also reduces the negative effect of time delay on the price of options, all without limiting the profit potential.
To enter this position, the trader buys an in-the-money option at a higher price and sells an out-of-the-money put option at a lower price, on the same security and with a common expiry date. The result is a debit spread, which is a net loss and an upfront cost to the trader because the purchased options are more expensive than the written options. The goal here is to lower the cost of purchasing a put option and to raise the breakeven point of the spread.
The maximum risk derived is the cost of entering this position and the commissions incurred. But, the lower the strike chosen, the larger the profit potential. Although, if you do this, you receive less credit to offset the cost of entering the trade.
3. Bear Butterfly Spread
The bear butterfly spread is made up of two long calls that have a middle strike and a short call that covers the upper and lower strikes. A trader uses it when anticipating that a security’s price will decline and is confident about the extent of that fall.
The bear butterfly spread takes three transactions that complicate it. But, fortunately, the three moves help to advantage in that it brings down the transaction costs. Also, you can use it with either calls or puts, and get the expected outcome.
It involves writing puts whose strike price is equal to the anticipated price at the expiration date. For every two puts, you write, you buy another with a higher strike and another with a lower strike. The strikes should be as close to each other as possible so that you can cover most of the cost of buying the puts using the credit received from writing, leaving only a small net debit.
Note that the expiration dates for the three transactions must be similar, as well as the underlying asset. Also, the distance between the centre strikes and both the lower and the upper strike should be the same.
For this position, the maximum loss possible is the net premium paid and the maximum profit is the net credit, less the commissions paid.
4. Bear Iron Condor Spread
The short bear iron condor spread is a four-step position created using a bull put spread and a bear call spread.
The short put’s strike price should be lower than the short call’s strike price, and all should share an expiration date. A trader enters into this position for its net credit, and because the risk is capped.
For maximum profit, the underlying security’s price should be equal to or fall between the short option strike prices on the expiration date. At this point, the options expire worthless and the trader collects a net credit as income. The maximum profit is therefore the difference between the bull put spread strike prides, less the net credit.
The maximum risk is the variation between the bull put spread prices, minus the net credit received. It is achieved when the stock price lies below the lowest strike price or above the highest strike price, on the expiration date.
The bear iron condor is an advanced strategy and is not suited to beginner traders because of the high trading costs given that there are four options and commissions to pay. Experienced traders must also be careful to open these positions at good prices, taking into account the effect of the commissions on the returns.
5. Bear Put Ladder Spread
This strategy is an extension of a bear put spread. It is used to derive profit from the declining prices of a security, but it also involves an additional transaction that pulls down the initial investment needed to set up the spread. Use it when expecting a modest price fall as it can lead to significant losses where the price falls lower than predicted.
The bear put ladder spread involves three transactions. Start by buying put options to make a profit as the underlying security falls in price as predicted. Then, write an equal number of the put options at a lower strike before finally writing another equal number of put options again, but at a much lower strike.
Writing options helps to offset the costs of the options purchased, so, the trade does not have to be legged: you can do it all simultaneously. But, ensure that all the contracts have the same expiration date.
Opt for puts that are at-the-money or just about, and write a bunch of puts where the strike is equal to where you anticipate the price of the underlying security will be. For the next batch, use the next lowest strike.
Although the low strikes give you less money at the time of writing, they offer you a greater profit potential, which makes the deal a kind of trade-off.
The bear put ladder spread’s profit is capped, and a trader derives the maximum profit when the price of the underlying security falls between the put options strike prices.