Bearish Trading Strategies

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Bearish Trading Strategies

Bearish strategies in options trading are employed when the options trader expects the underlying stock price to move downwards. It is necessary to assess how low the stock price can go and the timeframe in which the decline will happen in order to select the optimum trading strategy.

Very Bearish

The most bearish of options trading strategies is the simple put buying strategy utilized by most novice options traders.

Moderately Bearish

In most cases, stock price seldom make steep downward moves. Moderately bearish options traders usually set a target price for the expected decline and utilise bear spreads to reduce risk. While maximum profit is capped for these strategies, they usually cost less to employ.

Mildly Bearish

Mildly bearish trading strategies are options strategies that make money as long as the underlying stock price do not go up on options expiration date. These strategies usually provide a small upside protection as well. A good example of such a strategy is to write of out-of-the-money naked calls.

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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

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Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

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Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

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Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Bullish and Bearish Option Trading Strategies

If you’re interested in trading options, you’ll find that the markets can be responsive and dynamic. Trading with Ally Invest provides insights and tools that can help you find appropriate option trades for just about any market outlook or environment. These trading environments can be categorized as bearish, bullish, neutral, or volatile. Each has its own trading strategies; we’ve provided examples of bullish and bearish strategies below.

Bullish Option Strategies

Bullish strategies are used when you forecast an increase in a security’s price. This security may be referred to as the underlying or simply the stock. The basic concept behind bullish options strategies is for these trades to result in a gain if the trader’s forecast of the underlying is correct. If your projections did not come to fruition in the prescribed time, the option trade may result in a loss.

Buying a Call Option

A call option provides you with the right to buy the underlying shares (usually 100 per contract) at a pre-negotiated price on or before a specific date. If the stock increases in price, the call option’s price may increase as well, allowing you to profit. If the call option’s price increases above the amount paid, you’ll realize a profit. However, it is possible for the call option to lose value and you would incur a loss. Too much time may have passed or there may have been a decline in the corresponding equity’s price. If this happens, you may lose a portion of or the entire amount of the call option’s value.

Buying a Protective Put

If an online stock trader owns or is long 100 shares of a stock, the trader may decide to protect this investment during times of market uncertainty or increased market volatility. If the online trader’s longer term outlook is bullish, one option trading strategy to consider would be to buy a put option online in order to hedge or protect the long stock position. The buyer of the put option obtains the right to sell the individual equity shares (usually 100 per contract) at a predetermined price on or before a certain date. This means if the stock declines in value, the put buyer has the right to sell the shares potentially for an amount higher than the current stock price. The put option acts like a home insurance policy. You hope you never need to use it, but it’s nice to know you have it. This comes at a price, known as the option premium. Even though the asset is now “insured” there is no limit to the upside profitability of the stock if the stock increases by more than the cost of the put option. If the stock stagnates or only increases slightly, the purchase of the put option may not have been necessary in hindsight. The trader may incur a loss on the put trade.

Bearish Option Strategies

If you foresee a decline in a stock’s value, you’ll likely employ a bearish options trading strategy that will take advantage of a decrease in the underlying asset’s price. This may cause the strategy to realize a gain. If your forecast is incorrect, the option strategy could net a trading loss.

The first bearish strategy most online traders learn is how to sell a stock short online. This is profitable if the stock declines in price lower than your sell short price. You would buy back the shares that you are short and close out the short stock position. If the stock increases in price, you will incur incremental losses as the stock rises in price. Because there is no limit on how high a stock may rise, short selling may result in unlimited losses.

Buying a Put Option

If you have the same market outlook as a short seller but wish to employ a trading strategy with lower and predefined risks, you can purchase a put option. Unlike the Protective Put strategy, you do not own the underlying stock.

As the buyer of a put option, you have the right to sell shares of the stock (usually 100 per contract) at a fixed price on or before the expiration of the put option contract. If the stock decreases, the put option may become more valuable as the stock trades lower and lower in price. This increase in the put option’s value allows you to sell the put option for more than you paid, netting a profit.

Trades don’t always turn out as planned and the same is true for buying put options. This bearish trading strategy may lose money if the put price declines in value. One reason this may occur is if the stock movement is opposite to your forecast and actually increases. Another reason could be that too much time has passed. However, your loss is limited to the cost paid for the put option.

Options trading strategies aren’t all black and white – there are numerous shades of gray when it comes to identifying a suitable approach. Different trading scenarios will require a different approach to investment.

Market neutral option trading strategies attempt to take advantage of a stock that is expected to be range bound or stagnant in price over a period of time. Although any price movement is possible, it’s unlikely that a stock will move severely in either direction during orderly trading conditions.

You may foresee increased volatility in a certain stock. That’s when your strategy should maximize exposure to increased implied volatility in options. Increases in implied volatility infer that the stock has a greater propensity to move either up or down. Use certain strategies to make a profit if the stock makes an extreme price move. If the stock stagnates or implied volatility decreases, you may incur a loss.

Ally Invest has a flexible and customizable options trading platform, designed to improve your experience. We’ll help you research the underlying stocks and provide access to invaluable market data and statistics, which play a fundamental role in deciding on a trading strategy.

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Bearish Market Trading Strategies

When your outlook on an underlying security is bearish, meaning you expect it to fall in price, you will want to be using suitable trading strategies. A lot of beginner options traders believe that the best way to generate profits from an underlying security falling in price is simply to buy puts, but this isn’t necessarily the case.

Buying puts isn’t a great idea if you are only expecting a small price reduction in a financial instrument, and you have no protection if the price of that financial instrument doesn’t move or goes up instead. There are strategies that you can use to overcome such problems, and many of them also offer other advantages.

On this page we discuss the benefits of using bearish options trading strategies, and some of the disadvantages too. We also provide a list of the ones that are most commonly used.

  • Why Use Bearish Options Trading Strategies?
  • Disadvantages of Bearish Options Trading Strategies
  • List of Bearish Options Trading Strategies

Why Use Bearish Options Trading Strategies?

First, we should point out that purchasing puts is indeed a bearish options trading strategy itself, and there are times when the right thing to do is to simply buy puts based on an underlying security that you expect to fall in price. However, this approach is limited in a number of ways.

A single holding of puts could possibly expire worthless if the underlying security doesn’t move in price, meaning that the money you spent on them would be lost and you would make no return. The negative effect of time decay on holding options contracts means that you’ll need the underlying security to move a certain amount just to break even, and even further if you are to generate a profit.

Therefore, buying puts options is unlikely to be the best strategy if you are anticipating only a small drop in price of the underlying security, and there are other downsides too. This isn’t to say that you should never simply buy puts, but you should be aware of how some of the downsides can be avoided through the use of alternative strategies.

There is a range of trading strategies suitable for a bearish outlook, and each one is constructed in a different way to offer certain advantages. An important aspect of successful trading is to match a suitable strategy to whatever it is you are trying to achieve on any given trade.

As an example, if you wanted to take a position on an underlying security going down in price but didn’t want to risk too much capital, you could buy puts and also write puts (at a lower strike) to reduce some of the upfront cost. Doing this would also help you offset some of the risk of time decay.

Another way to reduce the negative effect of time decay would be to include the writing of calls. You can even use strategies that return you an initial upfront payment (credit spreads) instead of the debit spreads that have an upfront cost.

Basically, bearish options trading strategies are very versatile. By using the appropriate one you cann’t only profit from the price of the underlying security falling, but you also have an element of control over certain aspects of a trade like the exposure to risk or the level of investment required.

Disadvantages of Bearish Strategies

Although there are clear advantages to using bearish options trading strategies other than simply buying puts, you should be aware that there are some disadvantages too. Most of them usually involve a trade off in some way, in that there’s essentially a price to pay for any benefit you gain.

For example, most of them have limited profit potential; which is in contrast to buying puts where you are limited only by how much the underlying security can fall in price. While this isn’t necessarily a huge problem, because it’s reasonably rare for a financial instrument to drop dramatically in price in a relatively short period of time, it does highlight that to get an extra benefit (such as limited risk) you have to make a sacrifice (such as limited profit).

In some respects, the fact that there are a number of different strategies to choose from is a disadvantage in itself. Although it’s ultimately a good thing that you have a selection to choose from, it’s also something of an extra complication, because it takes extra time and effort to decide which is the best one for any particular situation.

Also, because most of them involve creating spreads, that require multiple transactions, you will have to pay more in commissions. In truth, though, these disadvantages are fairly minor and far outweighed by the positives. The fact is if you can become familiar with all the various strategies and adept at choosing which ones to use and when, then you stand a very good chance of being a successful trader.

List of Bearish Strategies

Below is a list of the more frequently used strategies that are suitable for when you have a bearish outlook. There’s also some brief information about each one: including the number of transactions required, whether a debit spread or a credit spread is involved, and whether it’s appropriate for beginners.

You can get more detailed information on each one of these by clicking on the relevant link. If you would like additional help in choosing a strategy, then you can use our selection tool which you can find here.

This is a single position strategy that involves only one transaction. It’s suitable for beginners and comes with an upfront cost.

Only one transaction is required for this single position strategy, and it produces an upfront credit. It isn’t suitable for beginners.

This simple strategy is perfectly suitable for beginners. It involves two transactions, which are combined to create a debit spread.

This is relatively straightforward strategy, but it requires a high trading level so it isn’t really suitable for beginners. A credit spread is created using two transactions.

This is complex and not suitable for beginners. It requires two transactions and can create either a debit spread or credit spread, depending on the ratio of options bought to options written.

This is fairly complicated and not ideal for beginners. A credit spread is created and two transactions are involved.

The bear butterfly spread has two variations: the call bear butterfly spread and the put bear butterfly spread. It’s not suitable for beginners; it requires three transactions and creates a debit spread.

This requires three transactions to create a debit spread. It’s not suitable for beginners due to its complexities.

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