Bear Market Option Trading Strategies

This is an introduction to various option trading strategies from basic trades to complex, multi-leg trades for a falling market. The profits and losses discussed in these examples do not factor in commissions, interest, or taxes.

Buy Puts - (Risk: Limited / Reward: High) Buying puts is the most basic of bearish option strategies. Unlike short selling a stock, buying puts gives you a limited downside. Your maximum loss is the amount paid for your contracts. In order to profit from buying puts, you need to be right about the stock price falling, plus it needs to fall prior to the expiration date. Unlike short selling, buyers of puts have to be right on both the direction of the stock price, and the time frame in which it will occur.

Sell Naked Calls - (Risk: High / Reward: Limited) Selling naked calls is one of the riskiest of all option strategies. Your downside is theoretically unlimited. When you sell naked calls you collect a premium for the sale of the contracts in hopes that the stock price will remain under the strike price past expiration. That way the options will expire worthless, and you keep the entire premium. If you are wrong and the stock price rises above the strike price, losses can mount in a hurry. If you decide to employ this strategy, it's best to sell near term options since option prices decay quicker the closer you get to expiration.

Bear Call Spreads - (Risk: Low / Reward: Limited) Bear call spreads are generally created by selling at-the-money calls and buying the same number of out-of-the-money calls on the same stock. Like selling naked calls, you want the stock to fall below the strike price of the calls you sold prior to expiration, so you can keep the premium. The out-of-the-money calls you bought act as an insurance policy by limiting your downside risk if the stock moves up. The premium paid for the higher strike price calls cuts into your profit, but it limits your losses to the difference between the two strike prices times the number of shares controlled by your contracts. Your maximum profit from the trade is the premium you received for selling the calls, less the premium you paid buy the other calls.

Bear Put Spreads - (Risk: Low / Reward: Limited) Bear put spreads are generally created by buying at-the-money puts and selling out-of-the money puts. Like buying puts, your potential loss is limited to the cost of intitiating the trade. Since you are selling a put in addition to buying a put, the net cost of the trade is less than that of simply buying a put, but the gain is also limited. Your maximum profit for this trade is the difference between the strike prices multiplied by the number of shares controlled, less the net cost of initiating the trade.

Put Back Spreads - (Risk: Low / Reward: Limited) Put back spreads (which are bear ratio spreads that are net long options) are best used when you are expecting a large drop in an already volatile stock. The strategy involves selling a put at one strike price and buying more puts at a lower strike price. Ideally, the premium received for the sell, and paid for the buys, should be close to offsetting each other. This will greatly limit your downside should the stock move up in price. Maximum profit is achieved as the stock falls below the lower strike price. For this reason, many traders choose to initiate this trade using in-the-money puts.

To learn about option trading strategies for other market conditions and situations, visit our option strategy overview page.

The Clark Financial Group can help you implement all of your option trading strategies. We provide our clients with discount commissions, online trading convenience, and the support of an experienced broker at no additional cost. For more information, call us at 1-800-797-1979 or compare our combination of low fees and extensive services to see if we're right for your option trading needs.

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