Is the bear here? Have six years of solid yields in the stock market going to be wiped away by a massive correction? Should you be worried?
I have no idea, but I’m prepared to a certain extent whether or not a bear yields its ugly face. You can do the same, as long as you are approved for options trading.
Strategy #1: Make sure you have put options covering or exceeding the amount of shares you have in companies – for example if you are holding 100 shares of Apple which is worth around $106.25 after falling almost 7% in the past five days, you should hold at least one put option of Apple. The strike price for the put option is where a lot of the magic comes into play, as if you buy a put option with a strike price above Apple’s current market value you are making a very conservative play that will be handsomely rewarded if Apple stock price falls but costs a moderate amount more than an option with a strike price around $100 for example.
In my real-price example I will use the March 20th, 2015 expiration date. The Put option with strike price of $110 (above the market price of AAPL which is $106.25) costs $850. The put option for $100 costs $370. The difference is $480, which is less than the difference in share price for a given options “basket” which is $625. That means that It makes more sense to buy the more expensive put option if the stock falls, because even if it falls past the lower strike price you will be making more money.
Let’s say Apple falls to $90 per share by March 20th – with the more expensive put option you make $20 per share in your basket minus the commission which comes out to a profit of $1150. If you had purchased the cheaper lower strike price option you would make $630. Of course you stand to lose more if Apple goes up by March with the first option, which is why options being supported by a long ownership of Apple makes sense.
Strategy #2: Short the stock market. Sell shares of a company you don’t own with the intent of buying them back later at a lower price. This is a highly risky strategy as shorting a stock makes you liable to pay any dividends they issue from your account and without a call option to secure the short position the loss potential is astronomical. One company that is heavily shorted is Herbalife Ltd., which some hedge fund managers consider to be a pyramid scheme soon to be busted by the government. If you short the stock market you will make money in a bear market.
Strategy #3: Sell all of your stocks and invest in corporate bonds or bank CDs. This is sort of like giving up on high yield investing, find a bond that suits your risk level or go with a municipal bond that may offer tax savings at the state level. Even more risk averse you can put money into T-Bills, which is what countries like China have done to protect the value of their huge cash surplus.