Do you think that there'll be another stock market crash soon? Maybe in the next six months to 1 year?

Honestly, we’re due now for a serious correction or recession soon, so this show might just come at the best possible time. Recall that we did the hard research into “How Often Markets Crash” in Show 15 and found that 21 times since 1928 stocks fell at least 20%. That’s essentially once every four years, and it’s been eight years since the last significant market correction.

Naturally, we know that the best way to play a stock market crash, if we knew one was coming, is by purchasing put options. But which put options do you buy? How far out to you go for the expiration day? What strike prices work best? Are there some general trading rules we should follow?

Today, we'll answer all of these questions and more during our first little sneak peek inside the backtesting research that we'll be launching later this year.

Key Points from Today's Show:

Background on Research:

• Did a study to backtest option buying strategies when predicting a stock market crash. Looked at 15 different strategies over the course of two years (2007 to 2008), assuming that the timing is almost dead on.
• If your assumption is that the market is going to crash and you want to profit, you may have to hold through some long put options before you actually start to realize any money on the position.
• Tested on SPY, QQQ, DIA, and IWM — all of the major market ETF's, and then averaged out the numbers.
• Grouped everything into three different contract months — one month out (~30 days), two months out (~60 days), or three months out (~90 days).
• Bought options at the 10 delta, 20 delta, 30 delta, 40 delta, and the 50 delta for each of the different months to make up the 15 different back tested option strategies. Held everything to expiration, with no money/risk management.

Results and Findings:

• The front month, 30 day options performed badly the further out you bought. i.e the 10 delta and 20 delta options one month out were not great of performers.
• Whereas the 30 delta and 40 delta in the front month performed a little bit better — options either held more value closer to expiration or swung to a profitable zone.
• Results for the three-month options were completely reversed — when you bought options 90 days out at the 10 delta, you made on average about 211% over the course of two years (second highest overall value).
• The best opportunity for the option buying space was two months out. However, the 10 delta options did not make much money, neither did your 50 delta, 40 delta, or 30 delta options — all made money, but was not the best strategy (~160%).
• The best strategy is buying options 60 days out at a 20 delta and holding them to expiration. This strategy made 225% over the two-year period.

Backtesting Conclusion:

• With the 30 day/one month options, better buying closer in — buying options closer to out of the money, i.e 30 delta, 40 delta, or 50 delta.
• With the three-monthd options, 90 days out, it is better buying options further out — at the 10 delta and the 20 delta.
• The sweet spot and best strategy ends up being the two-month options, about 60 days out, and at about 20-25 delta, which ends up being really profitable as far as an option buying strategy.