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The S&P 500 lost more than 30% in the coronavirus crash earlier this year. Travel and oil markets seemed to get the worst of it, with cruise lines like Carnival Corp. (NYSE: CCL) and oil companies like Marathon Oil Corp. (NYSE: MRO) each losing more than 70% between January and March.
Money Morning's options trading specialist, Tom Gentile, was ahead of this. In February, Tom wrote about these stocks and how you could buy their put options expiring 60 to 90 days out for a substantial profit. Both options strategies earned readers more than 300%.
Now, with cooler weather and the regular flu season just around the corner, it is possible that a second wave of coronavirus cases is coming, too. We have an idea of what industries will be affected, but as Mark Twain is reported to have said, "History doesn't repeat itself, but often rhymes."
Knowing different ways to trade put options can be a huge help now that you've seen this movie before. Here are some of the simpler put option strategies that anyone can learn and do, just in time for a potential down draft in the market.
But if you're not so bearish and anticipate some kind of rally once election tensions simmer down, we have an options strategy for that, too.
Remember, options don't need a huge move in the market to throw off huge profits. For a much lower price than the underlying stock, you can participate in nearly the same price gain. The percentages can easily top triple digits.
Buying Put Options
The first strategy is the simplest – just buy a put option on the stock you think is about to fall in price. This is also called a "long put," because when you own something in your account, you are said to be "long." Being "short" would be the opposite.
A long put gives the holder the right, but not the obligation, to sell shares of the underlying stock at a specific price – called the strike or exercise price. You choose to sell at a specific date – called the expiration date.
These parameters make trading options a tad more complicated than just trading stocks, but the little bit of extra work can pay off in a big way. Typically, you want to buy a put option with a strike price at or close to the current price of the underlying stock. In this way, the price of the option moves nearly as fast as the stock. But since you invested a lot less money, your percentage returns can be much greater.
And remember, you are only risking the money you paid for the option. If you sold the underlying stock short, your risk could be unlimited if the stock price goes higher.
The Protective Put
The next strategy is called a protective put. It is simply buying a put on a stock you already own.
Whatever loss you might take as the stock price falls is partially or almost fully offset by gains in the put option. And if the market goes higher, the stock gain will be greater than the option loss.
Consider this to be a hedge, or just an insurance policy for your portfolio.
If the market does go down, but your outlook is generally more bullish, you can cash in your option and then wait for the market to bounce back.
Meanwhile, you lowered your cost to play.
The Bear Put Spread
Now we come to strategies using two related options.
The first is a bear put spread, also known as a long put spread. As its names suggest, you use it when you are bearish and you have to pay money to buy it (buy it long).
This is opposed to a short spread, where you get a credit in your account when you start – or sell – the spread.
It is an alternative to buying just a single put. What you do is sell a put with a strike price just below the current price of the stock, and at the same time you buy a put with a strike price closer to the stock price.
The money you receive for the sale of the lower strike put partially offsets the money you need to buy the higher strike put, thereby reducing your risk.
The tradeoff is that your maximum profit is capped. It is limited to the difference between the strike prices minus the net cost to start the trade.
The good news is that your maximum loss is simply the price you paid in the first place, which is lower than buying just a single put.
You use a bear put spread when you are mildly bearish or you want to be bearish at a lower cost.
Now, unlike all of these strategies, here's a put option strategy you can use if you expect a rally ahead…