How To Play Options In A Bear Market

Question From A Reader On How To Play Options In A Bear Market

Question From BP:

Would you be looking at stocks you DON’T want to own in the Long Term for buying puts or selling calls?  Things like NFLX (Netflix) or LVS (Las Vegas Sands Corp (etc.) and stay away from the MSFT (Microsoft) and XOM (Exxon Mobil) type stocks of the world.

Or do you just trade the ETF’s on the Indexes?

My Answer

Hi BP and thanks for your question. What you are actually asking is How To Play Options in a Bear Market.

The first thing I can tell you  is I only buy SPY Puts and do not do options against ANY of the other Indexes. I am a stock person through and through. I believe that ETFs definitely have a place in the investing world and I definitely believe that many investors would be best served through investing in ETFs.

But when it comes to how to play options in a bear market, I have always found that individual stocks work much better for me. This could easily be because I have been investing for so long (35 plus years) that I was in the market before all the mutual funds and ETFs even got started. There were mutual funds in the 1970’s but truly they were a handful in relation to the thousands available today.

Here is a good example. Take a look at this list of INVERSE ETFS and INVERSE ETNS that are available today and which definitely serve well in a bear market. I have always found Inverse Funds difficult to buy and trade therefore I stay with my SPY PUT OPTION trades which I have written about many times.

HOW TO PLAY OPTIONS IN A BEAR MARKET – The Concern

When it comes to how to play options in a bear market the real concern for me is getting assigned on shares of stocks that I would have a difficult time rescuing from a stock collapse. That means in a bear market I am very careful about selling puts.

For example let’s look at Las Vegas Sands Corp which has the stock symbol of LVS.

Las Vegas Sands Corp is a very popular stock. The first thing I would do is look at the past chart of LVS and see how did it fare in previous bear markets. Below we can see that LVS collapsed into the $5.00 range. This stock was not trading during the bear market of 2000 to 2003 so there is no further bear market to look at.

First notice in the above chart that LVS has not regained to the levels seen in the summer of 2008 when the bear market was already ravaging stocks. That’s a good sign for selling naked calls against this stock. I WOULD NEVER BE SELLING NAKED PUTS against LVS.

There is no way I would want to be owning this stock in a bear market. For one thing there is no dividend. For example if you sold puts at $30.00 and LVS quickly fell to $20.00, the chance of assignment is incredibly high. A dividend will still help to support the stock, slow a drop in the stock and gives you as the investor a bit of income to use towards reducing your loss.

When it comes to how to play options in a bear market, the  question to ask is are you comfortable selling naked calls?  In a bear market or even a trending market such as what appears to be developing today, an investor has to know their comfort zone. A lot of investors find selling naked puts a lot easier than selling naked calls.

However in a bear market in my opinion, how you play options is you sell calls. If you believe the market is in a long term or even intermediate term down trend then selling naked puts doesn’t make a lot of sense for the reasons I mentioned above including the all important reason of not wanting to own the shares.

Instead if I sell naked calls and the stock rallies to my strike I can:

1. purchase shares to turn the position into a short term covered call
2. buy back the naked call for what will probably be a loss
3. roll the naked call further out and possible up since if it is a bear or down trending market then eventually the naked call should end up out of the money

HOW TO PLAY OPTIONS IN A BEAR MARKET – Deciding On What Call Strike To Sell

Looking at the past 6 months can give me a pretty good clue as to what strike I might sell. On Feb 3 2011 the stock hit a 6 month high of $50.28. Since then the stock has never retouched that level and in fact it could be making a double top here. I would be waiting for a rally then I would consider looking at the various call strikes available for the next month out.

Here is the options chain for September 2011 Options Expiry. Today (Aug 3) with the big drop and then rally back up, the $52.50 strike is could be sold for .71 or 1.3%. I would wait for a rally higher which I believe after today’s dramatic reversal will occur tomorrow and could last a few days. This may even give the opportunity to sell the $55.00 strike which is even better for the chance to not be assigned.

If an investor was uncomfortable going out to September, below si the chart for August 20 Options expiry on LVS. The August $52.50 today traded for just .12 cents so there is no premium worth selling against. However a rally over the next day or two could push the $50.00 into a decent amount for selling calls against.

How To Play Options In A Bear Market – Conclusion

Thanks for your question. You can see that while I would not be selling put options against stocks I would not want to hold if assigned, I do not see the same problem within bear markets. If anything, stocks that plummet in past bear markets are probably good candidates to search out and consider. It is important to remember though that in a bear market, how to play options is different than in a bull market. However should in fact the bear market not actually beginning, then selling calls could not be the strategy to consider. When selling options you must have confidence in the overall direction of the market, short term or otherwise. Those are the key to how to play options in any market.