Employing a ‘bear put spread’ strategy can serve as a protective measure against potential market downturns.
Editor Thenews24.net
3 min read
I’ll discuss some factors contributing to the recent stock market decline and provide an update on a hedge strategy I use during market volatility. On July 1st, I suggested hedging against an unusually unpredictable election year. Since then, the situation has become even more unpredictable, and the hedge has been extremely profitable. The S&P 500 5,350 puts I mentioned are now trading at nearly $170, up about $12,000 per contract, despite the S&P 500 only dropping 2.3% since my initial recommendation.
Several factors are driving the market selloff. Recent economic data, including disappointing employment figures and negative revisions, suggest a possible recession. McDonald’s earnings echoed earlier warnings from Starbucks about consumer struggles, evidenced by rising delinquencies, decreasing savings, and various surveys. Additionally, the political landscape has shifted. Since President Joe Biden stepped down and Kamala Harris was chosen as the Democratic candidate, her poll numbers have improved, which, while positive for Democrats, has not been favorable for stocks. Cryptocurrencies have also been influenced by Trump’s rising poll numbers post-debate and post-assassination attempt, as he has shown strong support for them.
These factors, among others, have led to a significant increase in implied volatility, reflected in the VIX Index, which measures 30-day implied volatility on the S&P 500 Index. The VIX has more than doubled since July 15th, shortly after the Trump assassination attempt.
Currently, I am adjusting my strategy by converting the earlier recommended puts into a put spread. While a put spread can’t fully offset the higher premiums we’re seeing now, it can significantly reduce them. For instance, the S&P 500 August 30th 5,350 puts I recommended at $50 can now be sold for nearly $170. These can be rolled into a September 5,200/4,500 S&P 500 put spread, costing about $100. This move recovers the initial $50 premium and secures a $20 profit while maintaining downside protection to $4,500, offering more than 15% protection over the next seven-plus weeks.
A put spread, specifically a bear put spread, involves buying and selling put options on the same asset with the same expiration date but different strike prices. The strategy aims to profit from a decline in the asset’s price. If you missed the earlier article, here are the components of a long put spread, also known as a “Bear Put Spread”:
– Long Put Option: Purchase a put option with a higher strike price, such as the September SPX 5,000 strike puts or SPY 500 puts, both proxies for the S&P 500.
– Short Put Option: Sell a put option with a lower strike price, like the September S&P 4,500 or SPY 450 puts.
How it works: If the asset’s price falls, the long put option’s value increases, while the short put option’s value also rises but to a lesser extent. Maximum profit is achieved if the asset’s price drops to or below the lower strike price. The maximum loss is limited to the net premium paid for the spread.
In high implied volatility periods, option premiums are higher due to anticipated larger price movements. Selling a put option in such an environment yields a higher premium, offsetting the long put option’s cost. High implied volatility increases the likelihood of significant price drops, enhancing the long put option’s potential to become deeply in-the-money, maximizing the bear put spread’s profit potential. While high volatility raises the cost of buying options, the bear put spread strategy limits the maximum loss to the net premium paid, making it more attractive than outright put option purchases, where the potential loss is the entire premium paid.
DISCLOSURES: (None) All opinions expressed by CNBC Pro contributors are solely their own and do not reflect the views of CNBC, NBC UNIVERSAL, their parent company, or affiliates. The content may have been previously disseminated on other platforms. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY. THIS CONTENT IS FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE FINANCIAL, INVESTMENT, TAX, OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.