Bearish Options Trading strategies for Falling Markets

Nilesh Jain

21 Mar 2017

Bearish Option Trading strategy is best used when an options trader expects the underlying assets to fall. It is very important to determine how much the underlying price will move lower and the timeframe in which the rally will occur in order to select the best option strategy. The simplest way to make profit from falling prices using options is to buy put. However, buying put is not necessarily the best way to make money in moderately or mildly bearish markets. Following are the most popular strategies that can be used in different scenarios.

Extremely Bearish - Long Put

Moderately Bearish - Bear Put Spread

Long Put Options Trading

When should you initiate a Long Put Options Trade?

A Long Put strategy is best used when you expect the underlying asset to fall significantly in a relatively short period of time. It would still benefit if you expect the underlying asset to fall gradually. However, one should be aware of the time decay factor, because the time value of put will reduce over a period of time as you reach near expiry.

Why should you use Long Put?

This is a good strategy to use because the downside risk is limited only up to the premium/cost of the put you pay, no matter how much the underlying asset rises. It also gives you the flexibility to select the risk to reward ratio by choosing the strike price of the options contract you buy. In addition, Long Put can also be used as a hedging strategy if you want to protect an asset owned by you from a possible reduction in price.

Strategy Buy/Long Put Option
Market Outlook Extremely Bearish
Breakeven at expiry Strike price - Premium paid
Risk Limited to premium paid
Reward Unlimited
Margin required No

Let’s try to understand with an example:

Current Nifty Price Rs 8200
Strike price Rs 8200
Premium Paid (per share) Rs 60
BEP (Strike Price - Premium paid) Rs 8140
Lot size (in units) 75

Suppose Nifty is trading at Rs 8200. A put option contract with a strike price of Rs 8200 is trading at Rs 60. If you expect that the price of Nifty will fall significantly in the coming weeks, and you paid Rs 4,500 (75*60) to purchase a single put option covering 75 shares.

As per expectation, if Nifty falls to Rs 8100 on options expiration date, then you can sell immediately in the open market for Rs 100 per share. As each option contract covers 75 shares, the total amount you will receive is Rs 7,500 (100*75). Since, you had paid Rs 4,500 (60*75) to purchase the put option, your net profit for the entire trade is therefore Rs 3,000. For the ease of understanding, we did not take into account commission

How to manage risk?

A Long Put is a limited risk and unlimited reward strategy. So carrying overnight position is advisable but one can keep stop loss to restrict losses due to opposite movement in the underlying assets and also time value of money can play spoil sports if underlying assets doesn’t move at all.

Conclusion:

A Long Put is a good strategy to use when you expect the security to fall significantly and quickly. It also limits the downside risk to the premium paid, whereas the potential return is unlimited if Nifty moves lower significantly. It is perfectly suitable for traders who don’t have a huge capital to invest but could potentially make much bigger returns than investing the same amount directly in the underlying security.

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Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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Bearish Options Trading strategies for Falling Markets

Nilesh Jain

21 Mar 2017

Bearish Option Trading strategy is best used when an options trader expects the underlying assets to fall. It is very important to determine how much the underlying price will move lower and the timeframe in which the rally will occur in order to select the best option strategy. The simplest way to make profit from falling prices using options is to buy put. However, buying put is not necessarily the best way to make money in moderately or mildly bearish markets. Following are the most popular strategies that can be used in different scenarios.

Extremely Bearish - Long Put

Moderately Bearish - Bear Put Spread

Long Put Options Trading

When should you initiate a Long Put Options Trade?

A Long Put strategy is best used when you expect the underlying asset to fall significantly in a relatively short period of time. It would still benefit if you expect the underlying asset to fall gradually. However, one should be aware of the time decay factor, because the time value of put will reduce over a period of time as you reach near expiry.

Why should you use Long Put?

This is a good strategy to use because the downside risk is limited only up to the premium/cost of the put you pay, no matter how much the underlying asset rises. It also gives you the flexibility to select the risk to reward ratio by choosing the strike price of the options contract you buy. In addition, Long Put can also be used as a hedging strategy if you want to protect an asset owned by you from a possible reduction in price.

Strategy Buy/Long Put Option
Market Outlook Extremely Bearish
Breakeven at expiry Strike price - Premium paid
Risk Limited to premium paid
Reward Unlimited
Margin required No

Let’s try to understand with an example:

Current Nifty Price Rs 8200
Strike price Rs 8200
Premium Paid (per share) Rs 60
BEP (Strike Price - Premium paid) Rs 8140
Lot size (in units) 75

Suppose Nifty is trading at Rs 8200. A put option contract with a strike price of Rs 8200 is trading at Rs 60. If you expect that the price of Nifty will fall significantly in the coming weeks, and you paid Rs 4,500 (75*60) to purchase a single put option covering 75 shares.

As per expectation, if Nifty falls to Rs 8100 on options expiration date, then you can sell immediately in the open market for Rs 100 per share. As each option contract covers 75 shares, the total amount you will receive is Rs 7,500 (100*75). Since, you had paid Rs 4,500 (60*75) to purchase the put option, your net profit for the entire trade is therefore Rs 3,000. For the ease of understanding, we did not take into account commission

How to manage risk?

A Long Put is a limited risk and unlimited reward strategy. So carrying overnight position is advisable but one can keep stop loss to restrict losses due to opposite movement in the underlying assets and also time value of money can play spoil sports if underlying assets doesn’t move at all.

Conclusion:

A Long Put is a good strategy to use when you expect the security to fall significantly and quickly. It also limits the downside risk to the premium paid, whereas the potential return is unlimited if Nifty moves lower significantly. It is perfectly suitable for traders who don’t have a huge capital to invest but could potentially make much bigger returns than investing the same amount directly in the underlying security.

Have Referral Code?