December 2, 2022

Paull Ank Ford

Business Think different

Bearish options trading strategies: How to use options in a bearish market

How to use options in in bearish market conditions - Motilal Oswal

An options contract gives an investor the right but not an obligation to trade in underlying instruments like stocks, index funds, etc., at a pre-decided rate.

An options contract that gives you the right to buy an instrument at a future date is known as the “call option”. An options contract that enables you to sell a security sometime in the future is called the “put option”. Options contracts are linked to an underlying asset and are valid for a set duration.

Before you begin to trade in options, you should know the best option strategy for a bearish market and a bullish market too. This post focuses on the former.

What are the option strategies for a bearish market?

When the market as a whole or a particular sector or stock price is falling, several bear market options strategies can help you protect your investments. Options can help you generate income for your portfolio in a declining market. Below we discuss a few of these strategies.

  1. Long put

Put options are one of the simplest ways to speculate on the price of an asset going down. You buy a put anticipating a decline in the price and hope to sell it at a higher price later. The long put limits your losses at the point of buying puts and is a great strategy to use when you expect a significant drop in the price. Few key points are:

  • Requires one transaction 
  • Involves upfront cost 
  • Beginner level trading expertise required 
  1. Short call

A short call is a strategy where you agree to sell an asset that you don’t own. The call seller is obligated to sell a security to the call buyer at the strike price if the call is exercised. If the asset price rises, the options you write could be exercised. You will have to buy the asset first and then sell it to the holder. If the asset’s value goes down, then you will make a profit. Key points are:

  • Requires one transaction 
  • Involves upfront payment 
  • High level trading expertise required
  1. Bear put spread 

The bear put spread is one of the popular bear market options strategies that helps you to maximise profit while minimising losses. You simultaneously purchase and sell puts for the same underlying assets with the same expiration date but different strike prices. A few aspects of this strategy are: 

  • Requires two transactions
  • Has an upfront cost
  • Low or medium trading expertise required
  1. Bear call spread 

It involves selling a call option and getting an upfront premium. You simultaneously purchase another call option with the same expiration date but a higher strike price. Few key points are:

  • Requires two transactions 
  • Involves an upfront payment
  • Medium or high trading expertise required

Conclusion

The best option strategy for a bearish market would depend on your objective; whether you wish to protect your investments against losses or want to earn profit from falling prices. If you’re new to options trading, you might want to seek the help of an expert to guide you through these investment decisions.