The stock market uses clever euphemisms to describe investor sentiment. When every thing is rosy, investors are optimistic and stock prices are rising, it is called a bull market. But when stock prices turn south and investors grow pessimistic, the bear takes over. You can make money trading options in a bear market, but it requires a different strategy.
Determine your main objective for trading options in a bear market. The strategy you employ will vary based on that objective. For example, your objective might be to protect your current stock investments against loss, to produce income from your current investments or to use falling stock prices to generate a profit. It is possible that your main bear market investment objective is a combination of two or more of these objectives.
Protect your current investments by purchasing protective put options. A put gives you the right -- but not the obligation -- to sell your stock at a set price for a set period of time. Purchase a put with the lowest strike price that you are willing to accept for your stock. This will allow you to protect your position by paying a smaller premium than if you buy a protective put that is close to or already in the money.
Generate current income in a bear market by selling covered call options on stock you already own. You'll receive a premium for agreeing to sell your stock at a set price for a set period of time. If the option is out of the money -- that is the strike price is above the stock's market price -- the option won't be exercised. You'll get to keep both your stock and the amount of the premium. If the stock bucks the trend and increases in value above the strike price, the option might be exercised. You'll still get the strike price for your stock and you will have the added bonus of the premium you received for selling the call option.
Speculate on the direction of the market by selling put options on stock that you have an interest in acquiring. You'll receive a premium for agreeing to purchase the underlying stock at a set price for a set period of time. If the market price of the stock remains above the strike price, the put option will expire unexercised. The premium you received will be pure profit. If the market price of the stock declines below the strike price, the option might be exercised and you will be required to purchase the stock at that price. The purchase price will be offset somewhat by the premium you receive, and you will acquire the stock at a lower price than was previously available.
- Trading options is a sophisticated investment strategy that is not appropriate for all investors. Options trading involves risk. You could lose some or all of your investment.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.