Put Options Go Up In Value As The Stock Market Falls
Using options to make money when the stock market falls is a way that stock traders and investors can make money during stock market sell-offs, while those holding long stock positions lose money.
The key to making money using options as the stock market falls is understanding how to buy put options that rise as stock prices drop. Not all put options are the same and not all will deliver the same amount of profit when stocks turn south.
Therefore, it is important to understand which put options should be purchased to make money as stocks lose value. It is also important to thoroughly understand what put options are and how they are traded.
There are many benefits to using put options to make money when the stock market falls. First off, who does not like to make money, no matter what the stock market is doing.
Second, using put options can allow a trader or investor to safely press their long positions to make greater gains without concerns about a sell-off.
Third, once the stock market has fallen and put options are cashed in, stocks are less expensive and can be purchased at discounts when compared to their peak prices.
How To Use Put Options To Make Money When The Stock Market Falls
Strong stock market uptrends can cause problems for traders and investors that are seeking to utilize their cash positions to make money as the stock market rises, but do not want to overweight their long-oriented stock exposure, in case the stock market reverses and falls sharply.
Put options associated with stock market indexes, such as the Standard and Poors 500 Index, provide a valuable way to use options data to predict stock market direction and profit from stock market sell-offs.
A put option is a contract that allows the holder of the put option to sell a specific amount of a stock or security at a set price by a specified date, which is the date when the option expires.
The set price is known as the “strike price”. Buying a put option for a stock or security puts a trader or investor on the short side of the stock or security trade, meaning that they make money if the stock or security goes down in price, since a put option will increase in price as the underlying stock or security falls in price.
Using SPY Put Options To Make Money When The Stock Market Falls
One of the simplest ways to profit from a fall in the stock market is buying put options written against the Standard and Poors 500 Index tracking spider security, known as SPDR S&P 500 ETF (NYSE: SPY).
SPY holds a basket of stocks included in the Standard and Poors 500 Index and tracks the movements of the index both up and down.
You can buy put options that derive their value based on the where the SPY is trading. If the Standard and Poors 500 Index and SPY fall, SPY put options increase in value.
Put options written against the SPY are priced in very small fifty-cent increments. This makes SPY put options quite useful for traders and investors looking to buy SPY put options at precise levels to make money off of downward moves in the Standard and Poors 500 Index.
SPY put options are priced on a weekly basis and expire at the end of each week, usually on a Friday.
It is important to keep in mind whether the SPY options you are considering buying cover a long enough time period to allow the stock market to sell-off. For example, you can buy SPY put options that expire at the end of the month of February, if it is currently February.
You can also buy SPY put options that expire during the month of March or many months in advance, such as December, or even two years in advance. Just keep in mind that the further away from the current date, the more expensive the SPY put options will be.
A SPY put option with a strike price of $210 might sell for $2.00, if the option is going to expire at the end of the current week and the SPY is trading at $212 per share. The same $210 strike price SPY put option might cost you $3.00, if it is set to expire a month later.
A longer dated $210 strike price SPY put option that expires in a year and a half from the current date might cost you $20.00.
For the purposes of effectively trading SPY put options, it is best to focus on either the current month’s options or nearby months, because these options are much less expensive than put options that expire in a year or more.
This because the people who sell SPY put options have to ask for a higher premium for options that expire a year or more out to protect themselves from the additional opportunities that the Standard and Poors 500 Index has to fall over longer periods of time, which would cost them money.
As the expiration date draws nearer, SPY put options gradually lose value. This is known as options “time decay”. What was once a $20.00 SPY putt option a year and half ago might sell for $2.00 to $3.00 as it nears expiration.
This is why it is best to focus on near-term SPY put options, since much of the time decay has already occurred. If the Standard and Poors 500 Index falls in the near-term, SPY put options will gain value, regardless of any time decay that has occurred over time.
An Example of How To Use SPY Put Options To Make Money
Here is an example of how to use SPY put options to make money. The stock market has been on a tear and the Standard and Poors 500 Index and its tracking spider security SPY are making all-time highs.
You suspect a pull-back in the stock market is coming due to upcoming Federal Reserve rate hikes next month. If SPY is trading at $212 per share as the market hits new highs, you could purchase 1,000 SPY put options with a strike price of $210 per share that expire at the end of next month.
Each SPY put option costs you $3, so you pay $3,000 for the 1,000 SPY put options. As expected, the stock market reacts in a knee-jerk reaction to Federal Reserve rate hikes and the Standard and Poors 500 Index loses 5% of its value, sending the SPY down to $200 per share.
Your SPY put options with a “strike price” of $210 are now selling for $9 per option, and you are able to cash-out by selling them for $9,000, booking a healthy 200% gain and netting $6,000.
Keep in mind that if SPY put options expire and the SPY is trading above their “strike price”, the holder of the SPY put options losses all of their initial investment. It is a high stakes way to play the stock market that can either provide big gains or total losses.