Three Consistent Trading Strategies for Bear Markets
Credit Spreads (Low Delta)
Basics of Credit Spreads
Definition: A strategy involving simultaneous buying and selling of options of the same type (call or put) with the same expiration date.
Credit: Designed to receive a net credit when opening the trade, meaning the option sold is more expensive than the option bought.
Types:
Put Credit Spread (Bullish): Assumes the stock price will be above the chosen strike prices by the expiration date. To open, you sell a put option with a higher strike price than the put option you buy.
Call Credit Spread (Bearish): Assumes the stock price will be below the chosen strike prices by the expiration date. To open, you sell a call option with a lower strike price than the call option you buy.
Credit Determination
The credit received depends on:
Strike Prices: How far in the money or close to the money the option is.
Expiration Date: Longer expiration dates generally lead to more credit due to increased time value.
In-the-Money (ITM) Options & Credit:
For a call option, it's considered in the money, and you receive more credit if the stock is below the strike price.
For a put option, it's considered in the money, and you receive more credit if the stock is below the strike price.
Delta Values and Strategy Goal
Delta's Role: Delta represents the approximate probability of an option expiring in the money. For credit spreads, the goal is often for options to expire out of the money (OTM) and worthless.
Target Delta: Typically, low delta values are preferred, generally between 20 and 30.
Call Credit Spread Example (Bearish on SPY)
Assumption: Bearish on SPY for the upcoming week.
Expiration Date: Next Friday, August 26.
Strategy: Call credit spread, as the assumption is bearish.
Strike Price Selection: Targeting a low delta value.
430 call has a 26 delta (approx. 26ackslash% chance of going against).
Adjusting for potential volatility, choose the 432 call with a 19.4 delta (approx. 19.4ackslash% chance of going against).
Trade Setup:
Sell: 432 call (base assumption: SPY will be below 432 by August 26).
Buy: 433 call (to act as collateral and define max risk, as no 100 shares of SPY are held).
Calculations:
Credit Received: 18
Collateral Required: The difference between strike prices multiplied by 100 shares.
(\$433 - \$432) imes 100 = \$100Max Loss (Max Risk): Collateral - Credit Received.
(\$100 - \$18) = \$82Max Profit: The credit received.
\$18
Filling the Order: To get filled quickly, sell for the lowest bid price (e.g., 18).
Outcomes:
Profitable: If SPY stays below 432 by expiration, the options expire worthless, and the full credit of 18 is kept.
Loss: If SPY is above 433 by expiration, the max loss of 82 is incurred.
Put Credit Spread Example (Bullish on SPY)
Assumption: Bullish on SPY for the upcoming week.
Expiration Date: Same as above, August 26.
Strategy: Put credit spread.
Strike Price Selection: Targeting a delta around 20.
410 call has a 12 delta (too low, minimal credit).
Choose the 415 strike price with a 22.3 delta (approx. 22.3ackslash% chance of going against).
Trade Setup:
Sell: 415 put (base assumption: SPY will be above 415 by August 26).
Buy: 410 put (lower strike price to define risk).
Calculations:
Credit Received: 75
Collateral Required: Difference between strike prices multiplied by 100.
(\$415 - \$410) imes 100 = \$500Max Loss (Max Risk): Collateral - Credit Received.
(\$500 - \$75) = \$425Max Profit: The credit received.
\$75
Closing the Trade: To close before expiration, perform the opposite actions: buy back the 415 put (buy to close) and sell the 410 put (sell to close).
Pros of Credit Spreads
Consistency: Can provide consistent income, especially when using low delta values that favor options expiring out of the money.
Small Account Friendly: Requires only the difference between strike prices as collateral (e.g., 100 for a 1 difference in strikes), making it accessible for accounts with limited capital (e.g., starting with \$1000).
Cons of Credit Spreads
Disproportionate Losses: Potential for larger losses than profits if the trade moves significantly against expectations, which can wipe away previous gains. Requires knowing when to exit quickly.
Pin Risk: A significant risk for small accounts. Occurs when a stock's price lands between the two strike prices at expiration. If both options expire in the money, the brokerage may exercise/assign them. If one option then goes out of the money, you could be exercised or assigned to buy/sell 100 shares without sufficient capital, leading to a deficit in your account. To avoid this, always close credit spreads before expiration if the stock is between your strike prices.
High Delta LEAPS Options
Basics of LEAPS Options
Definition: LEAPS stands for Long-term Equity Anticipation Securities.
Expiration: These options have a long expiration date, typically over a year out.
Functionality: Work similarly to weekly or monthly options, but with a much longer timeframe, allowing for long-term bullish (call LEAPS) or bearish (put LEAPS) assumptions.
Premium Structure
Time Value: Longer expiration dates result in higher premiums due to more time for the stock to experience volatility.
Intrinsic Value: Deeper in the money options also command higher premiums.
Call LEAPS: Lower strike prices (making them deeper ITM) mean higher premiums.
Put LEAPS: Higher strike prices (making them deeper ITM) mean higher premiums.
Delta Values and Strategy Goal
Target Delta: For high delta LEAPS, the delta value is generally kept between 70 and 90, indicating a high probability of the option expiring in the money.
Put LEAPS Example (Bearish on SPY)
Assumption: Bearish on SPY for the next year.
Expiration Date: September 15, 2023 (one year out).
Strategy: Buy a put option.
Strike Price Selection: Aiming for high delta to favor expiring in the money.
460 put has a 55 delta (too low).
Choose the 500 put with a 69 delta.
Calculations & Outcomes:
Cost (Max Risk): \$8125. This is the maximum loss if SPY is above 500 by the expiration date.
Potential Profit: If SPY drops from 423 to 400, the option would have \$10000 of intrinsic value ((\$500 - \$400) imes 100), resulting in approximately a 25ackslash% return.
Greater profit if SPY drops further.
Call LEAPS Example (Bullish on SPY)
Assumption: Bullish on SPY for the next year (with less certainty, thus higher delta).
Expiration Date: September 15, 2023.
Strategy: Buy a call option.
Strike Price Selection: Aiming for an 80-90 delta.
Choose the 350 strike price with an 82.3 delta.
Calculations & Outcomes:
Cost (Max Risk): \$9600 (or nearly \$9700). This is the maximum loss if SPY is below 350 by the expiration date.
Potential Profit: If SPY goes from 423 to 500, the option would have \$15000 of intrinsic value ((\$500 - \$350) imes 100), yielding over \$5000 in profit.
Pros of LEAPS Options
Time Advantage: Provides ample time for the stock to move in the anticipated direction.
Simple Risk: The maximum loss is clearly defined and limited to the premium paid for the option.
No Early Assignment Risk: As you are buying options, there's no risk of early assignment associated with selling options.
Cons of LEAPS Options
Higher Cost: Pay more for the extended time value and associated volatility.
Total Loss Potential: If the stock consistently moves against expectations and the option expires out of the money, the entire investment (premium paid) can be lost.
The Wheel Strategy
Basics of The Wheel Strategy
Definition: A two-part income-generating strategy that involves consistently selling options around owned stock.
Part 1: Selling Put Options (Cash-Secured Puts):
Sell a put option, agreeing to buy 100 shares of a stock at a chosen strike price.
This is typically done out of the money to reduce the probability of assignment.
Part 2: Selling Call Options (Covered Calls):
Once assigned 100 shares from a put option (or by buying shares directly), sell call options against these 100 owned shares.
Agree to sell the 100 shares at a chosen strike price.
This is also typically done out of the money.
Credit Determination (for Selling Options)
Expiration Date: Longer expiration dates yield more credit, as a longer timeframe implies more potential volatility.
Strike Price: Options further in the money will yield more credit due to intrinsic value. However, the strategy generally aims to sell out-of-the-money options to lower the odds of assignment.
Example (SPY) - Current Price \$423
Part 1: Selling Put Options
Goal: To acquire 100 shares of SPY at a discount, while also collecting premium.
Regular Purchase Cost: Buying 100 shares currently at \$423 would cost \$42300 (without any upfront payment).
Expiration Date: Two weeks out, September 2.
Strike Price Selection: Choose a strike price below the current market value (\$423).
Sell: 420 put. This means agreeing to buy 100 shares of SPY for \$420. Cash required for collateral: (\$420 imes 100) = \$42000.
Calculations:
Credit Received: \$450.
Breakeven Price (if assigned): Strike Price - Credit Received.
(\$420 - \$4.50) = \$415.50
Outcomes:
Profitable (No Assignment): If SPY is above 420 by expiration, the put option expires worthless. The \$450 credit is kept, and another put can be sold.
Profitable (Assignment): If SPY is below 420 by expiration, 100 shares are assigned at \$420. The effective purchase price per share is reduced to \$415.50 due to the credit. The strategy then moves to Part 2.
Part 2: Selling Call Options (Covered Calls)
Scenario: Assumed to own 100 shares of SPY after put assignment (or direct purchase).
Goal: Generate income by selling calls against the owned shares and potentially sell the shares at a higher price.
Strike Price Selection: Choose a strike price higher than the current market value (e.g., higher than SPY's historical cost basis).
Delta: Similar to credit spreads, look for low delta values (e.g., 20-30).
Sell: 433 call (with a 26 delta). This means agreeing to sell the 100 shares of SPY at \$433.
Calculations:
Credit Received: \$209.
Breakeven Price (related to selling the call): The speaker states this as the call strike price plus the credit.
(\$433 + \$2.10) = \$435.10
Outcomes:
Profitable (No Assignment): If SPY is below 433 by expiration, the call option expires worthless. The \$209 credit is kept, and another call can be sold.
Profitable (Assignment): If SPY is above 433 by expiration, the 100 shares are called away (sold) at \$433. The income generated from both the put and call premiums, combined with the difference between purchase and sale price, determines the overall profit.
Pros of The Wheel Strategy
Customizable Buy/Sell Points: Allows you to effectively choose the price at which you buy stock (at a discount via puts) and sell stock (at a premium via calls).
Consistent Income: Can generate a decent amount of regular income (e.g., \$1200 per month from 200 shares of AMD, as mentioned).
Equity Ownership: Unlike credit spreads, you eventually own the underlying shares, participating in potential long-term appreciation (while generating income).
Cons of The Wheel Strategy
Downward Risk (Put Side): If the stock price continues to fall significantly after put assignment, you will lose money on the 100 shares you were obligated to buy.
Downward Risk (Call Side): If the stock depreciates significantly while you own the 100 shares, you will lose money on the share value, even with covered call premiums.
Opportunity Cost:
Selling Puts: Could have potentially bought the stock for an even lower price had you waited.
Selling Calls: If the stock dramatically increases above your call strike, your shares will be called away, and you miss out on further potential gains (could have sold for higher had you not capped your upside).
High Capital Requirement: Requires a significant amount of capital to cover the purchase of 100 shares (e.g., \$42000 for SPY).