Bear Market Strategies—A Reminder

Just a quick blog today to alert my faithful readers as well as newbies to some strategies that can be employed in today's highly volatile market. The strategies I'll be mentioning all involve options, so if you don't know how to use them, please use the resource links to the right to educate yourself first. Now is a great time to employ trading schemes that take advantage of the high volatility, such as anything involved with selling options (especially puts).

If you want to buy a stock but are afraid that it'll still go down
Check out Recipe #6 on cash-secured puts. This is a great way to buy stocks, especially high-dividend paying, good growth stocks you'd like to own. The only requirement is enough cash to cover the cost of buying the stock at the strike price (and I dearly hope you have some cash left!) along with the approval from your broker. This type of trade is legal in retirement accounts, and it really depends on your brokerage firm if they'll allow you to do this. If not, you can easily transfer your account to a broker who will. (OptionsXpress is one firm who specializes in options trading. My IRA is with them and I've been very happy with their service and trade executions, and no, I'm not getting any compensation for the plug—alas.)

The major downside to this strategy is that the stock may trade right through the strike price and you could potentially be left with a loss. However, some insurance is already built into the trade in the form of money collected on the sale of the put. You can avoid further loss by buying a married put or an equity collar as soon as possible. (See next section for further info.) The upside to this strategy is that the stock will remain above the put strike price (write only front-month puts please!) and you can keep writing puts and collecting premium until the stock is eventually assigned.

If you want to protect a stock from further loss
Recipe #4, Part I suggests ways to hedge an entire portfolio using index options. Part II looks at ways of hedging a particular stock using married puts or equity collars. Since we're in a high volatility environment, I suggest using the latter strategy. Why? Because you'll be paying a high premium to buy the puts, but selling calls against it will mitigate that effect. Plus, if the stock keeps dropping, you have the added advantage of buying back the covered calls (at a much reduced price) and selling more calls at a lower strike. So, if your stock keeps dropping, not only will the value of your put increase (unless volatility decreases drastically) you'll also keep collecting premium on the sale of the calls. If you're vigilant on rolling down those calls, you might just end up with a tidy profit on the transaction!

This equity collar strategy can also be used to start protecting any ultra-short ETF positions. Most of these ETFs are optionable; however, liquidity with some of them can be an issue. This is when you must know what you're doing. NOTE: I wouldn't put on an equity collar until your position gets into the exhaustion phase, i.e. extreme price movement accompanied by very heavy volume.

Why should I use these strategies now?
Many market technicians feel that we're only in the middle of this bear scenario and have a good six months to a year of further downside. Based on what the charts of the major indices are telling me, I completely agree with them. Sorry to be the bearer of bad news, but by reviewing and using some of these recipes, you could possibly spare your portfolio and/or retirement account from major losses.