Do you get nervous when a stock goes on a downward trend?

Most people's reactions are usually one of the following two choices:

- One is to sell off immediately
- The other is to buy more to spread out the cost

Today I'll use Netflix as an example to show you how to make a profit in a bearish market.

Contents

## How Do You Buy a Put to Anticipate a Downward Trend?

Looking at the price chart of NFLX, we can see a clear downward trend since the company disclosed their Q1 earnings. The stock price has dropped 10% in 2 weeks.

If you reference Morningstar's fair value of Netflix, the stock is only worth $250, so we expect NFLX price to continue to drop.

Looking at the previous low of $497, we can buy a Put option at $495 to anticipate the bearish movement.

It costs around $1185 to buy a $495 Put that expires next month.

If the stock price drops below $495 before expiration, we can exercise the option to sell 100 shares at $495.

We can make $100 for every $1 decrease in the stock price.

But the Probability of Profit is only 30%, so it's not a high probability trade.

If NFLX goes on a long downward trend, the maximum theoretical profit of the trade is around $48000 as the price heads toward $0. But this is unlikely to happen to a financially strong company like Netflix.

From a different perspective, if you already own NFLX stocks, buying Put options is a good way to minimise your losses in a bearish trend. You have the right to sell 100 stocks at $495 no matter how far the price falls.

Although the maximum profit of a long Put is strike price x100, but the cost of buying Put is very high, and the option would expire worthless if the stock price doesn't fall.

So we can consider a higher leverage strategy of buying a Put Calendar Spread to profit from a market downturn.

## How to Buy a Put Calendar Spread?

It is more difficult to profit from a Calendar Spread than from a long Put, because you need to be very accurate in guessing both the direction and the size of the downturn to be profitable. But the advantage of a Calendar Spread is a lower cost of trade and a higher leverage.

If we look at the Netflix price chart from last year, the downward fluctuation is usually between $50-$100. So we can buy a Put Calendar Spread that is $100 below the current market price.

A bearish Calendar Spread is made up of:

- A short Put that expires next month.
- A long Put that expires in 2 months or more.

The maximum profit occurs when the stock price falls to exactly the Strike price within a month.

When trading with TD Ameritrade:

- Find the Puts that expire next month
- Right click to BUY Calendar

- Change Qty to 1
- Set the BUY Put to Exp next month

Then we can Analyze the trade.

We can see the cost of this Calendar Spread is around $90. If the stock price drops to the strike price within a month, we can make $1500, a 15x Return on Capital.

But it is very difficult to pull off this trade, and you can lose the initial investment if you are wrong about the trade.

Since we have covered the strategies on buying options, now we can talk about how to be the seller of options.

## How to Sell a Call?

If we believe the stock price will continue to fall, we can sell a Call option very close to the market price, at around -0.40 delta. As an option seller, we can receive the $1205 premium upfront.

Because NFLX is an expensive, and volatile stock, the Naked Call we sell would need a buying power of over $8600. Resulting in a Return on Capital of around 14%.

The analysis of this trade shows there is a 68% chance of profit after 1 month. As long as the stock price remains below our strike price, we can collect the full premium.

The drawback of this trade is if we are wrong about the direction of the stock price, we as the seller, will lose $100 for every $1 price increase, with a theoretical maximum loss of infinity.

How do we sell options in a safe way?

## How to Sell a Call Spread?

We can buy a Call at a higher Strike price to cap the loss of our short Call. This way, the buying power required would be reduced as well.

Even though the Call Spread has lower premium than a Naked Call, only $175, while maintaining the same 68% chance of profit. But a lower buying power of $325 means we can have a Return on Capital of more than 54%.

## Comparison of 4 Bearish Options Strategies

We discussed 4 Bearish option strategies today, and my personal favourite is selling the Call Spread. It has the highest Probability of Profit, and a great Return on Capital. As a seller, we can simply wait for the option to decay in value, then exit before the market price cross the Strike price.

Strategies | Pros | Cons |
---|---|---|

Buy Put | Easy to setup Can limit the losses of holding stocks High theoretical maximum profit | High cost of trade Low chance of profit |

Buy Put Calendar Spread | Low cost of trade High leverage | Need to be correct in both direction and magnitude |

Sell Call | Receive premium first High probability of profit Profit by waiting for options to depreciate in value | Requires high buying power Unlimited maximum loss |

Sell Call Spread | Receive premium first High probability of profit Low buying power required High leverage Profit by waiting for options to depreciate in value |

## High Probability Bearish Trades Right Now

The Bear Call Spread Screener uses chart analysis to find overvalued stocks with a high probability of a downward correction that we can sell Bear Call Spreads to open.

We want to find heavily overvalued underlying that have a high probability of going down.

- The options screener uses fundamental analysis to calculate the Fair Value of the underlying then compare that with the Last value to find the potential Upside of the stock. When the Upside is less than -30%, we have high confidence in a bearish outlook.
- Short Signal Price shows the topped out price from our technical analysis. So we know the stock price will not rise beyond this price in the short term.
- Short Days indicate the number of trading days has passed since the last short signal. As soon as the short signal appears, there is a high probability of a bearish move.
- We also need to avoid Ex-Dividend Date before options expiration. On one hand Ex-Dividend Date usually lead to rising prices and assignment. On the other hand, if you get assigned, you might need to pay dividends for shorting the stock.

Since we are strongly bearish about our trade, we can use -0.50 delta ATM Bear Call Spread to calculate Return on Capital. This gives us the highest return when we are right, and the lowest maximum loss if we are wrong.

So we can look at the screener for the best ATM Bear Call Spread ideas.

By combining Upside and Short Days, we see ENPH is one of the most overvalued stocks, and has a short signal 8 trading days ago. It doesn't have an Ex-Dividend Date coming up. So it has a high probability of a bearish trend.

By checking the Enphase price trends, we confirm ENPH reached a high point at $220, similar to the Short Signal Price in our Bear Call Spread list, 8 trading days ago, and has been bearish ever since. We expect ENPH to stay below Short Signal Price in the short term.

We can sell an ENPH ATM Call Spread option that expires in 35 days. If the ENPH stock price does not rise before expiration, we have the potential to profit 86% from the trade.

Now it's your turn to try the options trading strategies we shared today, and find your favourite bearish trading strategies.

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BobbyThese bearish trading strategies look interesting.

I’ll give them a try.

Patrick原來當Netflix被高估的時候還有這麼多的看跌交易方式

Tony是啊，只要學會交易選擇權，就可以在看跌的時候賣Call Spread

不但槓桿高、需要的保證金又少

IvyThank you for comparing different bearish option strategies.

I’ll try selling the Call Spread next time a stock is trending downwards.

TonySounds great.