FAQ Section

Bearish Strategies

How do I know if a stock is going to make a bearish move lower?

The reality is that you don't know if a stock is going to make a move in any direction and most often your assumptions will play out 50/50 at best long-term. You can use technical analysis to help improve your chances of making a correct decision on the ultimate move of a stock and as a general rule, we would always prefer to see the stock with overbought readings than to go short something at its low. Still, once you realize and believe that you have absolutely no real directional edge as a “stock picker” you’ll feel a weight lifted off your shoulders and be able to focus more closely on learning how to trade non-directional with options.

What is the difference between a bear put debit spread and a bear call credit spread?

Both strategies are options strategies you would use if you are directionally bearish on a particular stock. In the case of a bear put debit spread, you would be net buying options and assuming that the stock goes lower from wherever its current strike price is to a target. In this instance you would be buying one option ITM put option and selling one OTM put option to give you an overall debit or cost to get into the trade. A bear call credit spread is an options selling strategy whereby you sell one OTM call option and buy one OTM call option at a higher strike price to give you an overall net credit. Although you prefer for the stock to fall or sell off, with a credit call spread you leave additional room for the stock to rally higher without breaching your short call strike and still have the potential to profit.

If your bearish and implied volatility is low what are the best options strategies?

When you are bearish on a stock, and you see low implied volatility prevalent in the market, the best options strategies in our opinion is a put calendar spread. This is because you can play the stock directionally lower and have the ability to make money if implied volatility rises. We prefer to use put calendar spreads over debit put spreads in this instance because the rise in implied volatility can also improve the profit margin of a calendar spread more than that of a debit put spread.

How do I select strike prices on a bear put debit spread?

These strategies are bearish in direction so we'll be working purely on the put side of the option pricing chain. In our case, we like to buy one put option ITM above where the stock is trading and sell one put option OTM below where the stock is trading. You'll pay a net debit that hopefully should get you a break-even point very close to where the stock is currently trading in order to keep your risk to reward ratio around 50/50.

How do I select strike prices on a put calendar spread?

Calendar spreads are by their very nature much harder to select strike prices because you'll be looking at different contract months and the spread between those months. We like to place most of our put calendar trades one or two strikes out of the money. This ideally should maximize the pricing differential between the two contract months and give you the best possible risk-reward ratio. For example, if a stock is trading at $50 we would look to center the put calendar around $47-$49 strikes if we are bearish. Just to help show you how it works in the other direction, we would look to center a call calendar around the $51-53 strikes if we are bullish.

Which options do I buy and sell for a put calendar spread?

If you are buying a put calendar spread, you would first sell the front month option and then buy the back month option. For example, a Jan/Feb put calendar spread would mean that you are selling the January put options and buying the further out February put options.

What dictates the width of a calendar spread?

The width of a calendar spread is mostly determined by the pricing differential between the front month and back month options. The smaller the disparity in pricing the wider the calendar spread will be. This is because you will be taking more advantage of the time differential in the option prices as opposed to one option being dramatically more expensive than the other and effectively go long or short stock.

What should you look for when placing calendar spreads?

Calendar spreads are mainly used to profit from the rise of implied volatility. Though you can use them for directional trading purposes, it’s not their ultimate use. Therefore, we always suggest you use calendar spreads when implied volatility rank is super low, and you believe that market volatility will rise before the front month’s expiration date. If that were the case it would be the ideal setup for a calendar spread.

If your bearish and implied volatility is high what are the best options strategies?

The best options strategies include either selling a naked call option above the market or selling a bearish call credit spread. Both opportunities give you the edge in implied volatility and the bearish directional bias on the market that you are seeking.

How do I select the strike prices on a bear call credit spread?

The bear call credit spread is one of the ultimate trading strategies because it is a net option selling strategy and allows you to profit when stock prices are falling. Few investors realize just how powerful this strategy can be if you learn how to trade it correctly. The best way to select strike prices on a bearish call credit spread is to start with your targeted probability of success and then find the strike price above the market on the call side that gives you that probability of success. For example, if a stock is currently at $50 and the $65 call strike price has a 70% chance of winning, you might want to sell the $65 call options and buy the $66 call options to create your bearish call credit spread with a 70% chance of success. Alternatively, you could buy any options above $65 and still have the same probability of success but with different risk and reward characteristics. The key here is that everything starts with the short strike you select.

I'm bearish on a stock - but when should I use a debit spread vs. a calendar spread?

Both of these strategies would work if you were bearish on a stock, but the difference for us is where implied volatility is at the time you enter the trade. If implied volatility is very low (25 IV rank or lower) we suggest using a calendar spread as this strategy profits more from a rise in implied volatility than anything else. If implied volatility is low but not insanely low (25-50 IV rank) we suggest using a bearish put debit spread. As implied volatility is not yet low enough to buy and go long with a calendar spread, you'll see a better pricing opportunity with bearish put debit spreads in this example.

Should I ever just purchase long OTM put options if I think stocks will crash?

There is no evidence or body of research that proves long OTM put options are good profit vehicles for market crashes. Even if you predict the market crash will happen, which is nearly impossible to begin with, you'll pay a high a premium as the crash unfolds and as volatility goes up which will counteract the benefits of having that put option in your portfolio. Long put options can offer you the ability to protect your portfolio from quick and sudden moves down in the market but as a means to profit from a market crash they are not preferred. As a general course of business, we do not trade long OTM options here at Option Alpha and have never found them to be beneficial.