Note: We hope you’re enjoying all of your Opportunistic Trader content. That’s why we have a favor to ask…
Would you please add [email protected] to your contacts list?
That will “whitelist” us with your email provider and help ensure these emails reach your inbox. If you’d like to learn more about whitelisting, you can check out our detailed instructions here.
Thanks for your help!
When you think a stock is about to fall, the best way to trade it is not always clear.
You could short it directly… But some folks don’t have an account that allows that.
Another choice is to buy a put option. A put option increases in value when the underlying asset falls.
Yet options expire…
You might get your analysis right, but the move might take longer than you expected. Or the stock might not fall far enough to make your put option profitable.
That’s where another options strategy, a “bear put spread,” can help increase the chances that your trade will be successful…
Improving Your Breakeven
As the name implies, a bear put spread means that you are bearish about the underlying security and are using put options. A spread means you’re going to buy and sell put options simultaneously.
For the first leg of the trade, you buy a put option. For the second leg, you’ll sell a put option at a lower price. Both options should have the same expiry.
Adding the second leg reduces the move you need to get to breakeven.
In other words, the stock needs to fall less (compared to just buying a put option) for your trade to be successful.
The downside is that this strategy limits your profit potential.
So let’s see how you might put a bear put spread into action. (Note: This is a historical example and not a trade recommendation.)
Below is a chart of the Invesco QQQ Trust Series 1 (QQQ) from a couple of years back…
Invesco QQQ Trust Series 1 (QQQ)
Source: e-Signal
After a strong run-up, the Relative Strength Index (RSI) showed that QQQ was overbought (red circle). So you could place a trade to capture a potential mean reversion.
You might not be overly confident of a huge move down. But you still think that QQQ is vulnerable to a pullback if the RSI rolls over and starts heading lower.
So, in this example, you could place a bear put spread by buying a QQQ put at $330 for $5 (see “1,” upper orange line). At the same time, you sell a put at $320 (see “2,” lower orange line) for $3.
You’ve paid out $5 for the bought put option and received $3 for the sold put, so you’re out of pocket $2 for the spread trade. (Remember, each options contract represents 100 shares. So that $2 equates to $200 per contract.)
Your breakeven on the trade is now $328.
That’s the bought put strike price ($330) minus the $2 you have to recoup. That means QQQ has to fall below $328 for your trade to become profitable.
If you just bought the put by itself, QQQ would have to fall to $325 for you to break even. (That’s the $330 strike price minus the $5 you need to recoup before the trade becomes profitable.)
So it’s a matter of what you think QQQ is going to do…
|
Free Trading Resources Have you checked out Larry’s free trading resources on his website? It contains a full trading glossary to help kickstart your trading career – at zero cost to you. Just click here to check it out. |
Playing the Odds
By placing a spread, you’ve reduced your total spending from $5 to $2… and you’ve reduced the distance QQQ needs to fall for you to break even.
This does place a cap on your profits… You can make up to the $10 difference between your options’ strike prices ($330 and $320), minus the premium you paid out to open the position ($2).
So the most we can make on this trade is $8 – which equates to $800 per contract. Even if QQQ fell to $300, our profit on this trade is capped at $8.
Yet giving up the chance of bigger profits comes with an increased likelihood of success.
And this strategy significantly reduces the capital you need to make a trade, which becomes increasingly important once you begin to make multiple trades.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
P.S. The world is changing fast.
AI is now fueling the next wave of wealth creation in crypto – and tech expert Jeff Brown thinks this could be your chance to take advantage of the fusion of these powerful technologies.
According to him, those who understand how to play this moment could build generational wealth in the coming years…
That’s why Jeff wants to tell you about an AI system that’s detecting hidden patterns in the crypto markets that human traders simply cannot see…
And so far, Jeff’s system has a 79% win rate.
So if you’d like to learn more about this opportunity… mark March 12 on your calendar for the AI Crypto Fusion event.
And make sure to go right here to automatically RSVP.
Don’t get left behind during this pivotal moment…