Options Strategy Explanation 08 |Slight dip, making money through spread trading is the safest.

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Welcome to Options Strategy Explanation 08！

Today, we will be learning about two bearish spread strategies.

First, let me ask you a question. If we anticipate a slight future decline in stock prices, how can we use options to profit? Many options enthusiasts might think of buying put options or selling call options, but both of these strategies come with significant risks.

To begin with, if you buy put options and the stock price experiences only a slight decline, it's possible that the decrease may not be enough to offset the erosion of time value, leading to a drop in the put option's price and resulting in losses.

On the other hand, if you sell call options, although the win rate might be higher, if the stock price rises, the seller's potential losses are unlimited. This strategy can easily lead to uncontrollable risks when faced with unfavorable stock price movements.

Therefore, the best approach is to utilize bearish put spread strategies and bearish call spread strategies in a bear market to generate profits.

1、What is the Bearish Put Spread Strategy?

Let's address the first question. How can we avoid the risk of losses due to time value decay when buying put options in a situation of slight stock price decline? It's quite simple. We can sell another put option at a lower strike price, which will provide us with additional premium income to offset the premium cost of the bought put option.

By doing this, firstly, the premium cost will be significantly reduced. Secondly, although we lose the time value of the bought put option, we also gain the time value from selling the put option, resulting in a two-fold benefit. The only limitation is that our potential profit is capped in the event of a significant stock price drop.

For example, let's consider Li Auto with a current stock price of around $46.5. We anticipate a slight decline to $45.5 before August 18th. If we directly buy a put option with a strike price of $46.5, paying a premium of $2.47, even if the stock price drops to $45.5 by the expiration date, the put option's net profit, after deducting the premium, remains negative. The profit/loss amount would be $46.5 - $45.5 - $2.47 = -$1.47.

However, if we sell another put option at a $45 strike price, we would receive a premium income of $1.73. After offsetting the $2.47 premium cost, our net profit/loss would be $46.5 - $45.5 - $2.47 + $1.73 = $0.26.

Therefore, the benefit of the bearish put spread strategy lies in the fact that, when expecting a slight market decline, the overall profit of this combination remains positive. It helps mitigate the decay of time value, reduce premium expenses, with the only drawback being that in the case of a significant stock price drop, the strategy's profit is limited compared to simply buying put options. The maximum profit is the difference in strike prices of the two options minus the net premium paid.

2、What is the Bearish Call Spread Strategy?

As mentioned earlier, when anticipating a slight stock price decline, merely selling call options exposes us to potentially unlimited losses if the stock price rises. However, if we buy another call option at a higher strike price, we can cap our maximum loss. This approach also ensures that the overall premium income of the entire combination remains positive. How can we achieve this? Let's again use Li Auto as an example.

First, we sell a call option at the $46.5 strike price, receiving a premium income of $2.55. Then, we buy a call option at the $48 strike price, incurring a premium cost of $2.05. The net premium income is $0.5.

When the stock price falls below $46.5, the maximum profit for the entire combination is $0.5. If the stock price rises above $48, the maximum loss for the entire combination is $48 - $46.5 - $0.5 = $1.

The benefit of the bearish call spread strategy is that, compared to selling a single call option, it allows us to cap the maximum loss in case of price increases.

Well, this concludes today's strategy. If you find this article helpful, please feel free to leave comments and share. You might have a chance to win coins!