Bearish Options Strategies

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Chapter 26 — Bearish Options Strategies
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Bearish Options Strategies

Bearish strategies are used by traders who anticipate large and swift decreases in an underlying security. For example, if a trader believes a company is about to lose an important lawsuit, they will use a bearish strategy.

i. Long Put Option

Buying a put option, also known as going long on a put option, is the simplest bearish strategy. When buying a put option you are buying the right to sell the underlying security at a certain price. If the price declines, you can then buy the underlying security and exercise the option to sell at a higher price. The difference between the security’s current price and the exercise price is your profit. If you choose to sell the put option instead of exercising it, your profit will be realized from the higher value of the put option.

Put options are often considered a safe alternative to shorting stocks because it provides a lower level of maximum losses and a higher level of maximum profits. It can be used to build into more complex options trading strategies.

ii. Writing a Naked Call

When you write a call option, you are selling the right for someone to buy a security from you. Writing a naked call option means to sell a call option on a security that you do not own. It can be thought of like writing an option to sell a car that you don’t own (yet). If the price of the stock declines you will make a profit equal to the value of the option you sold, but your potential losses are unlimited if the stock begins to rise.

Writing a naked call option has similar characteristics to writing a naked put option. The time decay of the options contract will give you a profit even if the stock’s price doesn’t move. Just like the naked put option, the value of the call option you sold will decrease as the expiration date nears. This decrease in value is your profit.