Options Strategies for a Falling Market

Options traders can make money no matter which way the market heads. With the right strategies for a bear market, close attention to evolving fundamentals, and use of technical indicators profits can be made while investors are losing their shirts. What are some good options strategies for a falling market? Common approaches when markets fall include the bear call spread, bear put spread, and bear butterfly spread.

Bear Call Spread

The bear call spread is a strategy that we commonly use at Top Gun Options when we expect prices to fall. This approach also conforms to our policy of hedging our risk on all trades. In a bear call spread a trader both buys and sells equal numbers of calls for the same expiration date on the same stock or index. The sold call is for a strike price slightly above the market price. The purchased call is for a somewhat higher strike price. The trader receives a premium for the first call and pays a premium for the second. The difference between the two strike prices will determine the difference between premium and thus the initial credit for the trade. This trade starts with the maximum profit which remains so long as the market price falls or slides sideways. The worst case is when the market unexpectedly goes up in which the upper-priced call provides protection against further loss.

Bear Put Spread

Another approach that we use at Top Gun Options when we expect prices to fall is a bear put spread. The trader both purchases and sells equal numbers of put options. The first puts are in the money and this incurs an initial debit for the trade. Then the trader sells puts at a lower strike price which partially reduces the cost of the trade. Unlike the bear call spread which starts with a credit and maintains that credit when the market trades sideways, profit with a bear put spread requires that the market prices fall in order to gain a profit. And unlike the bear call spread which has an upper limit to its profit the bear put spread can provide substantial profits. You can think of this as a way to purchase a put for a cheaper price than by just buying the put. The maximum cost of this trade is defined by the price difference between the strike prices of the two puts. This gap also is how much the ultimate profit is reduced in the case that the market falls substantially.

Bear Butterfly Spread

A third approach when a trader expects the market to fall is the bear butterfly spread. A standard butterfly spread is an options strategy that includes both bull and bear spreads. The profit is limited as is the risk in this trade and it is typically used when the trader expects the market to slide sideways. A butterfly spread has four puts, four calls, or a combination set at three strike prices. A short butterfly spread for a falling market has two long calls at the middle strike price and short calls at the upper and lower strike prices. All of the expiration dates are the same and all calls are for the same stock or index. The strike prices are chosen so that the upper and lower prices are equally distant from the middle price. With setup the trader profits when the market price goes up above the top strike price or falls below the lower strike price. Loss occurs when the price remains within the bounds of the upper and lower prices. Thus, this trade not only profits in a falling market but in a rising one as well but, unlike the bear call spread, does not profit in a flat market.