If you think a company is about to pull back, it doesn’t always make sense to just sell naked puts. Today, I want to discuss some additional undefined risk trades I put on even if I’m a little bearish.
Put sales are my favorite strategy because the trade setup and management are simple. If I’m wrong, owning shares of the underlying gives me a second chance because shares never expire, and I consider them an asset. This doesn’t mean ‘bag holding’ a loser forever; I’m simply pointing out that if you are wrong in the short term, you have a second chance with a put sale that goes wrong.
But what if you think the company is going to pull back? You look at the moving averages, the stock is currently at resistance, or you see a bearish candle pattern. Selling a naked put doesn’t make sense if you have a bearish bias! Instead of waiting for a pullback, you can set up a trade that benefits as the stock pulls back. In other words, set up a trade that benefits from theta decay and offers a bonus if the stock falls into the “tent” of the risk curve.
Let’s take a look at the risk curve for some of my favorite trades when I have a bearish bias.
To keep this article semi-short, I’ll break down the specifics in a separate article with trade setup and management.
I recorded a video companion for this blog:
Let’s start with an introduction, and I’ll discuss how I think about these trades. If you have insights, I’d love to hear from you in our Discord, or shoot me an email!
Short Put:
When we sell a put we are 100% bullish on the stock.
In this example we are selling an 18 strike put and collecting $20. This is what this trade looks like on the options chain in Tasty Trade
As a quick reminder, I like to sell puts outside the expected range (the brown bar in the middle) and past the standard deviation (the blue dotted line), and I want to collect 1%, so the 18 strike for at least $0.18 for each 30 days.
This risk curve shows that if HOOD goes up, the max profit is the premium you collected.
As the stock goes up, this trade has a 93% probability of hitting a 50% profit target, which is $10. You will only make $20 no matter how high the stock goes up.
The max loss looks intimidating because if HOOD stock went to zero, you are obligated to buy those 100 shares. You can see the buying power is about $360 in a margin account.
Put Ratio Spread:
A put ratio spread is when you buy 1 long put and sell 2 (or more) short puts. The ratio is generally 1:2, but slightly more advanced ratios like 1:3 or 1:4 add more risk.
Keep in mind you can sell more than one ratio, so 2:4 depending on your account size and the share price. Size your trades evenly for the best risk management.
This is what it looks like on the options chain.
We are buying the 21 put and selling 2 20 puts. Do you see how this is right at the expected range (the brown bar) and we are still collecting over 1% of the strike?
Of course, we are not collecting the $0.47 credit we would if we just sold the 20 puts, but let’s look at the risk curve.
Notice that unlike a short put, we now have a "tent" between 19-21 in the share price. Instead of the $27 credit being our max profit, we see a max profit of $127 because we have a put debit spread mixed in with our sold put.
This is what the spread looks like. We're paying a $20 debit to make a max of $80.
The put ratio spread is an easy way to add a little hedge to a short put because we have added a put debit spread right above the short put sale.
1-1-1 Put Spread:
But what if you are even more bearish and you still want to start a position?
Please keep in mind HOOD's share price is pretty small. The reason I'm pointing this out is because a 1-1-1 can pay higher credits than today’s example. Do not sleep on this trade. Let me show you the setup, then I will tell you a cool way to convert this into an even better trade on a pullback.
This is what the options chain looks like:
The short put is still at the expected range, and you are adding a put debit spread like we saw with the put ratio spread, but all trades are at different strikes. I only sell 1-1-1s, meaning I want a credit for this trade instead of a debit.
I personally like to have a strike in between my two short puts. If you sold the 21 strike instead of the 20, you'd get a $16 credit. Max profit here is $108, still with a max loss owning shares at $20 a share less the put spread and credit we received.
Let’s look at the risk curve before you ask why I would take a trade that only pays an $8 credit.
If HOOD pulls back between 20-22 a share, you make $100. If HOOD bounces, you keep the credit received. This trade uses $575 in buying power.
If you were to move the 20 short put to the 21 (meaning you have a 23, 22, 21 strike), it looks like this:
Do you see the profit tent move from 21-22? You can make $120, but the size of the tent shrunk. The risk here is the same as selling a short put. The profit is the credit of the debit put spread to the downside.
Justin, 'why would you do this for such a small credit?' Because if HOOD drops and falls into that profit tent, I could sell another put for a really nice credit and create the next trade that I like to set up, the 1-1-2!
1-1-2 Put Spread:
A 1-1-2 has two short puts instead of just one. This means you have two short puts, meaning if left unmanaged, you are agreeing to buy 200 shares. So keep in mind the worst-case scenario. This is what the options chain looks like.
We sold 2 19 puts (right at the standard deviation) and created a put debit spread at 22-21, right between the 20 and 30 deltas and at the expected range. If you notice, we collected a $31 credit. We have great probability of profit, and we can make $131 on this trade. It requires $910 in buying power since we have 2 short puts. You can skew this trade to have less delta. As it’s set up, you get nice theta decay.
This is the risk curve.
The profit tent is between 19-21 per share. If HOOD bounces, you keep the credit. If the stock goes up, you still benefit from the 3.57 in theta decay!
These are a few of the trades I use when I anticipate a stock pullback. Each strategy offers unique advantages and can be tailored to fit your risk tolerance and market outlook. By adding these trades into your tool belt, we better navigate bearish conditions while still benefiting from potential upside.
If you want to dive deeper into these strategies or have any questions, join our Discord community where we discuss these topics in more detail.
Happy Trading, Good Kids!
$Maxwell
If you need more personalized help with your trading, you can schedule a 1:1 intro call with me through my Calendly link click the image below!
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