I'm not an experienced options trader, so what I'm about to tell you reflects my very recent learnings in the domain.
When you're convinced (like I still am) that the coronavirus has not been fully tallied up in especially the american stock prices, you might want to benefit from the situation.
A simple thing to do would be to buy a bear ETF, such as the Xtrackers S&P 500 2x Inverse Daily Swap. Nothing wrong with that.
But the challenge with such instruments is that high volatility leads to quite low performance. If the SP500 goes down -10%, then up +10% and again down -10%, what is the performance of the above ticker?
1.20*0.8*1.2 = 1.152, so +15.2%. As the volatility continues it eats up the gains.
You could also just sell short stocks. While that's also great, there's theoretically unlimited downside risk in that. If the SP500 is trading at 2500 now, you short it and it starts recovering and after reaching 2700 again you decide to call it. How much are you in the red? 7.5%. If it goes down though, how much do you think you can win? If it goes to 2400 you've won 4%.
While theoretically unlimited downside risk, in practice it's quite improbable. But the market does have quite big swings these days.
Bear call spread
Someone on Twitter mentioned bear call spreads, which I had heard before but never done myself. This was a few weeks back and things looked quite certain back then.
Here's how a bear call spread works.
First of all, someone holding a "call option" has the right to buy an underlying security at a certain price (called strike price) at expiry.
If you've sold a call option, then you are required to sell the underlying security at a certain price at expiry.
Naturally, if the security is trading below the "strike price" at expiry, then no-one wants to exercise a call option and they become worthless.
In a bear call spread you buy a call option and sell one.
You buy a call option (the right to purchase the security) at a price that's above current trading price. That limits your risk.
You sell a call option (the obligation to sell the security) at a price that's lower than current trading price, hoping the price will go lower.
And set the expiry at some date in the future, a week from now, or two.
By doing this, you've bought something of low value today and sold something of high value today. By doing this, your broker gives you credit.
Here's an example from 29.3.2020.
- SPY is trading at $253.39
- The price of a call option at 270 strike price on 13th of April is $4.91
- The price of a call option at 240 strike price on 13th of April is $21.61
- Since a single options contract typically includes 100 options, we multiply the prices with 100
- Doing this bear call spread will credit $1670 in your account.
This options profit calculator tool is extremely helpful to understand what's going on.
If by end of 13th of April 2020 the SPY is trading at 240 or lower, you get to keep what was credited to your account.
If on that day the SPY trades at the same level as today, you will still actually make $320, or 24%.
If by end of 13th of April 2020 the SPY is trading at 240 or lower, you get to keep what was credited to your account.
If on that day the SPY trades at the same level as today, you will still actually make $320, or 24%.
If the SPY has risen above $256.70, which is just 1.3% higher than today, you'll start to make a loss.
Trading at 270 or higher at expiry, you'll make the maximum loss of $1330.
Trading at 270 or higher at expiry, you'll make the maximum loss of $1330.
What happens at expiry
If the security is trading below the strike price, the option is said to be "out of the money", OTM. If it is still so at expiry, the option expires worthless.
When the security is trading above the strike price, the option is said to be "in the money", ITM. If it is still so at expiry, the option is exercised (or should be, since it is valuable).
If an option is in the money at expiry, then it should be exercised as it is valuable. It might be that this incurs a loss. You do have an option to "roll" the options to the future, by selling your current spread and buying a similar spread with a new expiry date.
Rolling an option spread
I've made up some of my this year's losses back with bear call spreads and I intend to continue with them. Nothing too huge, but small bets in places where it looks like the market is overbought or -sold.
It might happen that my bear call strategy is going to expire with a loss. If you let that happen, then the options will be assigned at expiry and you need to sell at a loss (the lower leg) and potentially exercise the buy call (if the price is higher).
But if you would want to avoid that, you have an option to roll the spread forward. This costs a little bit, since you're exchanging a very likely loss to a less likely loss.
But if you would want to avoid that, you have an option to roll the spread forward. This costs a little bit, since you're exchanging a very likely loss to a less likely loss.
Options traders, I want to hear from you
Are you experienced in options trading? If yes, drop some comments to improve this article.
Also, what are some of your most common options trades you use?
