How to trade a bearish view

Sell in May and Go Away. If you are bearish and you would like to execute this trading idea, there are several methods you can use. In this post, I will reveal two frequently used methods to ‘short’ the market. However, if you are unsure, stay calm and do nothing! A lot of time, doing nothing can save us a lot of money!

Method #1: Buy SPY Put Options 

Pull out 1 year SPY daily chart and if you think the market will drop to below 38.2% fibonacci level around 200 (Basically, I mean if you are bearish) and SPY is trading at 207.25 at the point of typing; you can do the following:-

Buy 200 PUT SPY 16 Sep

a. Buy Put SPY -> You bet the market will go down & you are willing to pay the premium (it also means you are willing to lose the premium paid if SPY does not drop below the agreed strike at expiration. You can however avoid this by closing the position much earlier before the options expired)

b. 200 -> You bet the market will drop below this level. You are buying far out of the money options (much cheaper; more leverage; but more risky too). Base on the option chain below, you will need to pay ~$5.7, which is $570 per option contract. If SPY drops to 180 at the expiration, you will make $1430 per option contract. If SPY trade at/above 200 at the expiration, you will lose $570 per option contract

c.  16 Sep -> 129 days from today before the options expired. Why select 129 days? Because you need to give the market enough time to drop. Do you need to wait 129 days until the options expire in order to close the position? No; you should keep this position for roughly one month and close it regardless your are making good profit or loss at that point of time before the option time decay waterfall effect starts to kick-in.

Screen Shot 2016-05-10 at 10.03.46 PMScreen Shot 2016-05-10 at 10.04.52 PM

Method #2: Buy VXX Call Options

This method is used to trade the volatility of the market. When market is going up, VXX will drop and vice versa. From the chart below, it is obvious that the market is approaching all-time high. There are two spikes hitting 30 level happen in Aug/Sep 2015 & Jan/Feb 2016 (flash crashes).

Buy 20 CALL VXX 16 Sep

a. Buy 20 CALL VXX -> You bet the market will go down and hence the volatility will spike. You don’t mind to lose the premium paid, roughly $140 per option contract. From option strategy perspective, it is considered aggressive because we are buying far out of the money options (much cheaper; more leverage; but more risky too). However, there is a concept called reversal to mean (basically it means what comes down will go up and vice versa). As the volatility now is already very low, it will not stay low forever. We can consider this as a good trade base on this view.

b.  16 Sep -> Same explanation as method #1 maturity date selection.

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Have fun trading!

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