Bearish Strategies

Bearish - Long Puts

Long Put Options
Function: Speculation
Outlook: Bearish

When you buy put options, you are said to be going long put options.  Buying puts gives investors the opportunity to leverage their investment and make more money with what capital they have.  However, in order to be able to leverage profits, you also bear the risk of leveraging losses.  Thus buying puts is risky, in that if the underlying asset does not fall below the strike price, the investor loses 100% of what he paid for the put.

If you own stock and you buy put options tied to that stock to protect yourself from a fall in the stock price, you are buying protective puts, which is a different strategy than buying puts without owning the underlying asset.

Long Put Payoff Graph:

Long Put Payoff Graph

 

Bearish - Naked Calls

Naked Call Options
Function: Speculation
Outlook: Bearish

When someone writes (sells) call options against stock that they do not own, the calls are called "naked calls."  They are naked because they expose the seller to unlimited losses.  If someone owns calls on a stock and sells an equal or lesser number of calls against the same stock, they calls sold are not considered naked because the calls he owns are server as collateral.
Since writing naked calls expose the writer to virtually unlimited losses, most brokers usually require that the writer have a minimum cash balance in his account, usually $100,000 or more.

Example:  Advance Micro Devices (AMD) trades for $15, and you think it will go down in price within the next month.  You sell ten one-month call contracts with a strike price of $16 for $.95, netting you $950.00 (10 contacts x 100 shares per contract x $.95 per share).  If the stock closes anywhere below $16 on the day of expiration, you get to keep the full $950.  If it closes anywhere above $16, you are obligated to buy 1,000 shares (10 x 100) at the market price and sell them for $16.  Thus, if the stock goes to $21, you will lose $4,150 ($21,000 - $16,000 + $950).  You could also simply buy the calls back at a price of $5 per share ($21 - $16), which will still result in a net loss of $4,150.

 

Naked Call Payoff Graph:

Naked Call Payoff Graph

 

Bearish - Bear Put Spread

Function: Medium-Risk Speculation
Outlook: Bearish

Establishing a Bear Call Spread involves buying a put at a higher strike price and selling a put with the same expiration date, but with a lower strike price than the put you bought.  Compared to most option spreads, the bear put spread is a low risk, low reward strategy.  You make a profit if the underlying stock goes below the price of the put option that you sold.

The profit for a bear put spread is maximized at the difference between the price of the put option you sold less the price you paid for the put option you purchased.

 

Payoff Graph for a Bear Put Spread:

Bear Put Spread

 

Bearish - Bear Call Spread

Bear Call SpreadFunction: Medium-Risk Speculation
Outlook: Bearish

Establishing a Bear Call Spread involves buying a call at a higher strike price and selling a call with the same expiration date, but with a lower strike price than the call you bought.  Compared to most option spreads, the bear call spread is a low risk, low reward strategy.  You make a profit if the underlying stock goes down below the price of the call option that you sold.


The profit for a bear call spread is maximized at the difference between the price of the option you sold less the price you paid for the option you purchased.

Example: Yahoo (YHOO) trades at $45, and you believe it will go down over the next month.  You write (sell) a 1-month call with a strike price of $44 for $2.10, and you buy a 1-month call with a strike price of $46 for $.50.  You have a net cash inflow of $160.00, excluding commissions ($2.10x100 - $.50x100).  If the stock ends anywhere below $44, both call options will expire worthless, and you will be able to keep the entire $160.

 

Bear Call Spread Payoff Graph:

Bear Call Spread

Bear Call SpreadFunction: Medium-Risk Speculation
Outlook: Bearish

Establishing a Bear Call Spread involves buying a call at a higher strike price and selling a call with the same expiration date, but with a lower strike price than the call you bought.  Compared to most option spreads, the bear call spread is a low risk, low reward strategy.  You make a profit if the underlying stock goes down below the price of the call option that you sold. 
The profit for a bear call spread is maximized at the difference between the price of the option you sold less the price you paid for the option you purchased.

Example:  Yahoo (YHOO) trades at $45, and you believe it will go down over the next month.  You write (sell) a 1-month call with a strike price of $44 for $2.10, and you buy a 1-month call with a strike price of $46 for $.50.  You have a net cash inflow of $160.00, excluding commissions ($2.10x100 - $.50x100).  If the stock ends anywhere below $44, both call options will expire worthless, and you will be able to keep the entire $160.