It isn’t a hidden fact that investors can make money when stock prices go down. One way to do this is by shorting shares of companies that investors believe won’t perform well because profits will be lower, sales will be stagnant, and so on and so forth.
No doubt, short selling is beneficial when stock prices are falling, and it certainly lets investors make money; however, if the stock prices go in the opposite direction, investors can be in for a long period of misery—their losses can even be more than 100%. In addition, in order to short, investors need to meet a certain amount of capital requirement in their portfolio.
Instead of just short selling a stock and putting up the capital, thereby exposing themselves to greater risk, investors can make money when the stock price is falling by using an option strategy called the “bear put spread.” This option strategy provides investors with a limited-risk, low-capital option.
Consider this: Google Inc. (NASDAQ/GOOG) trades well above $700.00. To simply short 100 shares of this company, investors require a significant amount of capital.
At the very core, a bear put spread requires investors to buy a put option strike price above the current stock price, in anticipation of stock prices falling, and a write/sell put option at a lower cost than the current stock price. One key aspect investors must remember is that these two put options should have the same expiry date.
Suppose ABC, Inc. is trading at $30.00 per share now, but an investor believes that the stock price will decline. So, instead of short selling, he/she decides … Read More
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