Author: Chris Hood
Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.
I admit it.
My bias on the market is naturally bullish.
Since I focus on probabilities, I know that stocks and indexes have a much greater chance of going up than down over time.
But even in an uptrending market, there will be pullbacks, and some stocks will get hammered.
We’re actually seeing this right now with the huge sell-off that’s underway.
Though my portfolio leans heavily toward long positions, I love the quick money that can be made on the short side.
My two favorite plays on weak stocks and sell-offs are long calls on inverse ETFs (such as SPXS, LABD, and SQQQ) and long puts.
Let’s take a closer look at the long put strategy.
Just as a reminder, when you buy a long call, you make money as the stock price rises. The leveraged return gives you a much higher % upside for a lower entry cost than buying the actual stock.
It’s also a much cheaper way to trade equities than buying shares.
The long put is precisely the reverse of this.
When you purchase a long put, you make money when the stock price drops. Again, the put provides a much higher %return at a far lower cost for the trade than just shorting the stock.
Though it’s possible to make huge returns quickly on the short side, you can get creamed if the market suddenly rebounds.
Before we go any further, I want to clarify something – buying a put is an entirely different strategy than selling one.
Never confuse the two.
Put selling is a bullish strategy and one I never recommend for beginners. The risk-reward just isn’t favorable.
For example, assume I thought the S&P 500 were going to rebound tomorrow, and I sold a naked put using the following order:
SELL SPY 100 28 May 21 405 @ 7.93
My max gain on this trade would be $793.00, but my max loss would be $39,707.00.
If I’m wrong, the market is going to punch my account in the nuts.
I feel duty-bound to make this distinction when discussing puts. I never want you to go through the same painful and expensive learning curve that I did.
For the long put, we buy an ATM or ITM put on weak underlying equities.
These trades could be for the same week expiration or for hundreds of days out, depending on your outlook and trading style.
I recommend staying away from put buying when the market is in a long-term uptrend.
Remember, the trend is your friend, and minor deviations from an overall bullish trend always have a high probability of sudden reversals.
This is the one time that I recommend adding a stop loss on your trade, and I use 20%. If my option price drops by 1/5 of the price, I’m out.
If you decide to use the long put strategy, make sure that:
Price is trending below both the shorter and longer period EMAs
Price is trading below key resistance levels
The IV rank is below 0.50, so you aren’t overpaying for the option
There’s something to be said for holding a few bearish positions in your portfolio, even in a bullish market.
If every position is long, then all will suffer when the market drops.
The best traders are those who can make money regardless of the market condition.
So it’s imperative that even if you’re a perma-bull on the market, you flesh out your toolkit with some bearish and neutral strategies.
The more tools you have, the more consistent your profits.
As always, when you’re learning a new strategy and developing your rule set around it, spend some time paper trading.
You’ll get first-hand experience in how the trades work and how to manage it properly – without risking real money.
As always, options cannot be learned without some time in the trenches.
Get in there and try it out.