Top Strategies for Bearish Options Trading
Options trading is a versatile and dynamic financial market tool that allows traders to profit from price movements in various assets. While bullish strategies capitalise on rising prices, bearish options trading strategies are designed to take advantage of falling prices.
We will delve into seven of the best bearish options trading strategies that traders can employ to navigate a downward-trending market.
7 Best Options Trading Strategies
1. Long Put Option Strategy
The long put option strategy is a straightforward bearish technique that involves buying put options on a particular underlying asset. A put option provides the trader with the right, but not the obligation, to sell the underlying asset at a predetermined strike price before the option's expiration date.
As the underlying asset's price drops, the value of the put option increases, enabling the trader to profit from the decline. This strategy is particularly effective when anticipating a significant downward movement in an asset's price.
Example: Suppose you are a trader and you have a bearish outlook on the stock of Tata Motors (current market price ₹300). You expect the stock's value to decrease in the near future. To capitalize on this anticipated downward movement, you decide to implement the long-put option strategy.
2. Bear Call SpreadOption
A bear call spread is a limited-risk, limited-reward strategy that involves selling a call option with a lower strike price and simultaneously buying a call option with a higher strike price on the same underlying asset.
This strategy profits from a moderate decline in the asset's price. The premium received from selling the lower strike call partially offsets the cost of buying the higher strike call, limiting potential losses.
Bear call spreads are ideal when the trader expects a slight or gradual decrease in the asset's value.
Example: Anticipating a bearish trend for Nifty 50, a trader sells a call option with a strike price of ₹15,000 and simultaneously buys a call option with a higher strike price of ₹15,200. This strategy allows them to profit from a moderate downward move in the index while limiting potential losses.
3. Long Ratio Put Spread Option
The long ratio put spread, also known as the back spread, is an aggressive bearish strategy that aims to profit from a significant downward movement in an asset's price.
It involves buying more out-of-the-money put options than the number of in-the-money put options sold. The goal is to generate a potentially large payoff if the asset's price experiences a sharp decline.
While the risk is limited to the initial investment, this strategy requires careful timing and analysis to maximise its effectiveness.
Example: You buy 1 Put option on Infosys with a strike price of ₹1,200 for ₹20 and simultaneously sell 2 Put options with a strike price of ₹1,000 for ₹10 each. This strategy helps you profit if Infosys falls significantly while limiting your losses.
4. Short Selling with Protective Puts Option
Short selling is a widely used bearish strategy that involves borrowing and selling an asset with the intention of buying it back at a lower price, thereby profiting from the price decline.
Short selling carries unlimited risk, as an asset's price can theoretically rise indefinitely. To mitigate this risk, traders can employ a protective put strategy.
By purchasing put options on the same asset, traders limit potential losses if the asset's price unexpectedly rises. This combination allows traders to benefit from downward price movements while managing risk.
Example: You short-sell 50 shares of HDFC Bank at ₹1,000 each. To protect against potential rises, you buy 1 Put option on HDFC Bank with a strike price of ₹1,050 for ₹15.
5. Straddle Strategy Option
The straddle strategy is a unique bearish approach that involves buying both a put option and a call option on the same underlying asset, with the same strike price and expiration date.
This strategy profits from significant price volatility, regardless of whether the price moves up or down. In a bearish context, the straddle strategy can be employed when there is uncertainty about the direction of the price movement but confidence in the occurrence of a substantial market shift.
While it can be costly due to purchasing two options, the potential profit can outweigh the initial investment.
Example: Ahead of a major earnings announcement for Infosys, a trader buys one call option contract and one put option contract on Infosys, both with a strike price of ₹1,500. This strategy profits from significant price movement in either direction after the announcement.
6. Long Put Butterfly Spread Option
The long put butterfly spread is a less common but effective bearish strategy that combines elements of both the long put and bear put spread strategies.
It involves purchasing one lower strike put option, selling two at-the-money put options, and buying one higher strike put option. The goal is to profit from a modest decline in the asset's price while minimising potential losses.
This strategy is suitable when the trader expects the asset's price to decrease slightly and remain within a specific price range.
Example: With Wipro trading at ₹400, a trader combines a bearish vertical spread and a bullish vertical spread by simultaneously buying one call option with a strike price of ₹390, selling two call options with a strike price of ₹400, and buying one call option with a strike price of ₹410. This complex strategy aims to profit from low volatility and a specific price range.
7. Synthetic Short Stock Option
The synthetic short stock strategy is a versatile bearish technique that simulates the profit potential of short selling without actually borrowing and selling the asset.
It involves simultaneously buying a put option and selling a call option on the same underlying asset, both with the same strike price and expiration date. This strategy profits from a decline in the asset's price, and the risk is limited to the net premium paid or received.
Synthetic short stock is a useful alternative when short selling is not feasible due to borrowing restrictions or other market limitations.
Example: You buy 1 Put option on TCS with a strike price of ₹2,800 for ₹50 and sell 1 Call option with a strike price of ₹2,800 for ₹40. This creates a similar outcome to short-selling TCS stock.
Conclusion
Bearish options trading strategies provide traders with a range of tools to profit from declining asset prices, enabling them to navigate and potentially capitalise on bear markets or downward trends.
Each strategy offers a unique balance of risk and reward, and the choice of strategy depends on a trader's market outlook, risk tolerance, and investment goals. As with any trading strategy, careful analysis, risk management, and a solid understanding of options are essential for successful implementation.
Whether utilising simple techniques like long puts or more complex strategies like synthetic short stock, bearish options trading can be a valuable addition to a trader's toolkit.
Frequently Asked Questions
1) What is the most bearish option strategy?
Ans - Among the spectrum of options trading strategies designed for bearish market conditions, one of the most straightforward is the act of purchasing or selling puts, a technique commonly embraced by many options traders. This approach thrives on pronounced downward market movements. Alternatively, traders with a moderately bearish outlook often establish a specific price objective for the anticipated decline and opt for bear spreads as a means to mitigate expenses.
2) What are the 4 option strategies?
Ans - For beginner investors seeking to safeguard against potential losses and mitigate market risks, several fundamental options strategies can prove invaluable. In this context, we will explore four of these strategies: purchasing call options, acquiring put options, implementing covered calls, initiating protective puts, and utilizing straddles.
