Bearish Options Tradings:
In bearish Options Trading, We expect it to fall in price; we will want to be using suitable trading strategies. A lot of beginner options traders believe that the best way to generate profits from an underlying security falling in price is simply to buy puts, but this isn't necessarily the case.
Buying puts isn't a great idea if we are only expecting a small price reduction in a financial instrument, and we have no protection if the price of that financial instrument doesn't move or goes up instead. There are strategies that we can use to overcome such problems, and many of them also offer other advantages. Some of categories are listed here .i) Why Use Bearish Options Trading Strategies. ii) Disadvantages of Bearish Options Trading Strategies.
Why use Bearish Options Trading:
· First, we should point out that purchasing puts is indeed a bearish options trading strategy itself, and there are times when the right thing to do is to simply buy puts based on an underlying security that we expect to fall in price. However, this approach is limited in a number of ways.
· A single holding of puts could possibly expire worthless if the underlying security doesn't move in price, meaning that the money we spent on them would be lost and we would make no return. The negative effect of time decay on holding options contracts means that we will need the underlying security to move a certain amount just to break even, and even further if investors are to generate a profit.
· Therefore, buying puts options is unlikely to be the best strategy if you are anticipating only a small drop in price of the underlying security, and there are other downsides too. This isn't to say that we should never simply buy puts, but we should be aware of how some of the downsides can be avoided through the use of alternative strategies.
· There is a range of trading strategies suitable for a bearish outlook, and each one is constructed in a different way to offer certain advantages. An important aspect of successful trading is to match a suitable strategy to whatever it is, investors are trying to achieve on any given trade.
· As an example, if we wanted to take a position on an underlying security going down in price but didn’t want to risk too much capital, we could buy puts and also write puts (at a lower strike) to reduce some of the upfront cost. Doing this would also help investors offset some of the risk of time decay.
· Another way to reduce the negative effect of time decay would be to include the writing of calls. Traders can even use strategies that return them an initial upfront payment (credit spreads) instead of the debit spreads that have an upfront cost.
· Basically, bearish options trading strategies are very versatile. By using the appropriate one, investors can't only profit from the price of the underlying security falling, but traders also have an element of control over certain aspects of a trade like the exposure to risk or the level of investment required.
Disadvantages of Bearish Strategies
Although there are clear advantages to using bearish options trading strategies other than simply buying puts, we should be aware that there are some disadvantages too. Most of them usually involve a trade off in some way, in that there's essentially a price to pay for any benefit traders can gain.
For example, most of them have limited profit potential; which is in contrast to buying puts where traders are limited only by how much the underlying security can fall in price. While this isn't necessarily a big problem, because it's reasonably rare for a financial instrument to drop dramatically in price in a relatively short period of time, it does highlight that to get an extra benefit; we have to make a sacrifice.
In some respects, the fact that there are a number of different strategies to choose from is a disadvantage in itself. Although it's ultimately a good thing that we have a selection to choose from, it's also something of an extra complication, because it takes extra time and effort to decide which the best one for any particular situation is.
Also, because most of them involve creating spreads, that require multiple transactions, traders will have to pay more in commissions. In truth, though, these disadvantages are fairly minor and far outweighed by the positives. The fact is if we can become familiar with all the various strategies and adept at choosing which ones to use and when, then we stand a very good chance of being a successful trader.