by Amanda Harvey
Bear market strategies are designed to allow a trader to profit even when stock prices are falling. Options are an excellent vehicle for thriving during a bear market, as they allow investors to trade with the movement of prices; whether that movement is up, down or sideways. A bear market can also be a time to buy value stocks at reduced prices while there is often a spate of panic selling.
This article explores some approaches that can be taken to benefit from a market that is experiencing a downturn.
Buying Put Options
One of the simplest bear market strategies is to buy put options. These options increase in value when the stock price falls, and buying them is usually done with one of two intentions.
Firstly, they may be bought as a speculative investment. This is when the trader does not hold shares in the underlying stock, but is purchasing the shares with the expectation that the share price will drop. If this prediction proves correct, the trader can then sell the option at a higher price than the initial premium, thereby generating a profit.
Alternatively, put options may be purchased as a method of hedging a position that a trader holds in the underlying stock. If the price drops as expected, the gain achieved from the put options offsets the loss incurred by the stock. This type of strategy is tantamount to buying insurance, and is a widely acknowledged way of reducing losses in the event of a market downturn.
Using Bear Call and Put Spreads
These bear market strategies use a combination of two transactions, and are both a method of profiting from the decline in stock price.
A bear call spread involves selling a call option contract with a strike price at or around the current market price, and buying another call option contract on the same stock with a higher strike price, with both contacts expiring on the same date. The profit for this strategy is attained at the outset, in the amount of difference between the price received and the premium paid. The risk in using a bear call spread in limited to the difference in strike prices, minus the initial gain received.
A bear put spread is executed by buying a put option contract below the market price, and selling another put option contract on the same stock at an even lower price. The revenue from the sale of the second contract helps to counteract the outlay and reduce the risk for the first contract. Profit is obtained if the price drops as expected, and the first contract can be sold at an increase.
Buying Value Stocks
For investors seeking longer-term gains, a bear market may present excellent opportunities to buy value stocks at low prices. Warren Buffett considers a bear market an excellent time to buy shares in companies that he deems to be worthwhile.
A Final Word
By understanding and effectively implementing bear market strategies, including the use of options, it is possible for a trader to make money in any market conditions.