Major technology stocks like Apple and Amazon.com are reeling this month. Here are some options strategies to know if you’re getting bearish.
This article will cover:
- Bearish put spreads
- Collar trades
- Hedging with ETFs
You might want to check this earlier post about calls and puts. To review, puts fix the price where a stock can be sold. They can gain value when shares decline. Calls are just the opposite although investors can also use them to achieve a bearish effect (as we’ll see below).
Bearish Put Spreads
Bearish put spreads involve buying puts near the money and selling other contracts further from the money. The closer-strike puts can appreciate from the stock falling. The options further from the money generate premium that lower the overall cost of the position. Remember, lower cost increases leverage — one of the key goals of trading options.
The following examples are for educational purposes only. Amazon.com (AMZN) has made a series of lower highs since September 4 while holding roughly $3,100. Some chart watchers may view that as a descending triangle with the potential for further downside.
An options trader could potentially create a spread by:
- Purchasing the October 3000 puts for $119.65
- Selling October 2800 puts for $51.50
- That would translate into a cost of $68.15 per share, or $6,815.
What do they get in return? If AMZN drops under $3,000, the position will sell shares at that level. It will also buy for $2,800 if the stock falls to that price. They’ll collect the $200 difference — a gain of about 193 based on their entry cost.
This strategy is also known as a “vertical” spread. (Using calls it can profit from a move higher.) A key benefit of put spreads is that they let the investor profit from gains in the stock while still protecting against a decline.
Hedging With Collars
Apple (AAPL) has a similar chart pattern as AMZN. It’s been trying to hold about $110 while making lower highs. Say an investor owns 100 shares.
He or she could hedge with a collar by:
- Selling 1 October 115 call for $4.80
- Buying 1 October 100 put for $5
- It would cost $0.20 per share, or $20.
This strategy effectively locks in a minimum selling price of $110 on AAPL — no matter how far it may fall. It also prevents them from making any money from the shares rallying above $115 because they’re short calls at that level.
Collars can be less expensive than put spreads. They also provide unlimited gains to the downside. However they remove the potential to profit from rallies higher. (Unlike spreads.)
Hedging with ETFs
If large stocks like AMZN and AAPL were to sell off, it could drag the S&P 500 and Nasdaq-100 lower.
Traders can respond by taking downside positions in these heavily traded exchange-traded funds (ETFs):
- SPDR S&P 500 ETF (SPY): The most actively traded instrument in both the stock and options market, tracking the S&P 500.
- Invesco QQQ Trust (QQQ): Similar to SPY, but following the Nasdaq 100.
In conclusion, stocks rallied for five straight months as they rebounded from the coronavirus correction. But they’re begun September on a weak note. Hopefully this post helps you know some ways to protect against further declines if they occur.
Disclaimer: The symbols and strategies in this article are intended for educational purposes only and shouldn’t be interpreted as recommendations.