Options Theory: The Bear Tamer
July 22, 2022
In the Bear Market Survival Guide, I explore the idea of protecting a stock portfolio. The simplified version of the strategy involves a diagonalized collar, but we dubbed it “The Bear Tamer.” Here’s what it looks like.
- Step One: Buy 100 shares of your favorite broad market ETF (SPY, IWM, QQQ, etc.)
- Step Two: Buy a one-year, 10% OTM put option as insurance to limit your risk.
- Step Three: Sell a sequence of one-month far OTM covered calls to help finance the cost of the put.
Here’s what the position might look like if initiated now using the S&P 500 ETF.
- One: Buy 100 shares for $396.
- Two: Buy Jun 2023 $355 put option for $19.
- Three: Sell Aug $419 covered call for $1.74 (it’s a 0.16 delta)
Here are the key trade metrics.
- Max Gain: Since we sold the $419 covered call, our profit is capped at around $1,700 or 4.3% for the next month.
- Max Loss: The long $355 put option limits our risk to approximately $5,876 or 15%. Essentially we paid about 5% of our position for an insurance policy with a 10% deductible.
By adding the protective put and covered call to the long stock, we morphed a position with unlimited reward and open-ended risk into a limited risk position with only 15% downside and roughly 4% max upside each month.
Call Strike Selection
There are a few considerations for choosing which call strike to use. First, I don’t want to cap my gain in the stock too quickly. This incentivizes me to sell as far OTM as I can. Second, I want to receive enough premium over the year to hopefully offset the entire cost of the protective put. Thus, I can’t sell too far OTM. To ensure the second objective gets accomplished, I take the put cost and divide it by the number of months to expiration. For the example above, we purchased an 11-month put for $19. That translates into a per-month cost of $19/11 = $1.72.
Thus, $1.72 is my target premium for the monthly call I sell. In other words, I sell a one-month call that is as far OTM as I can go while still receiving $1.72. That’s how I decided to use the Aug $419 strike price.
How to Cheapen the Insurance Further
Adding another $1,900 to the already hefty $39,650 required to purchase 100 shares can be a tough pill to swallow. Essentially, we’re paying another 5% of our position value to acquire the insurance. There is a way to reduce the cost. Turn the long put into a put vertical spread by selling a lower strike price against it. For instance, you could buy the June 2023 $355 put for $19 while selling the June 2023 $250 put for $4.50. This creates a June $355/$250 bear put spread for a total cost of $14.50.
The advantage is you cut the price tag of your protection by nearly one-quarter (from $19 to $14.50).
The disadvantage is your protection will end if SPY falls below $250.
Personally, I think it’s a worthwhile tradeoff in this case. If SPY does fall to $250, it will be down 50% from the highs.
If we can reduce the insurance cost to $14.50, then I actually don’t need to receive as much credit on the short call each month to pay for it. Indeed, $14.50 works out to $1.32 per month. Instead of selling the Aug $419 strike call, I can now sell the Aug $422 strike call w which opens up another $300 of profit potential in the stock before I’m capped.
If you want to learn more about the Bear Tamer, check out the Bear Market Survival Guide system and join me every month in the Mastermind Group Meetings where we discuss anything and everything about applying the system.
Read more Options Theory [FREE Content]
Every Thursday our resident options addict, Tyler Craig, will be at the helm to help you demystify derivatives and better understand what truly makes them tick. Options for beginners? Come this way, please. Enlightenment awaits.
Financial freedom is a journey
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Legal Disclaimer
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.
Nice summary Tyler. But how about the Bear Lover? Rather than just taming the Bear, why not embrace it?
Here’s one way:
1. Wait for an inter-day peak on one of the aforementioned ETFs.
2. Sell a call 1-2 days from expiration to lock in rock-star theta & some negative delta
3. If the ETF price rises afterwards, scale into a position as needed, say 25 shares at a time.
4. If ETF price continues to rise, increase stake to 100 shares at short strike.
5. If short call goes ITM, roll up & out
6. Place stop loss for shares at break-even
7. Wait for short call to expire OTM, or let your shares be taken away if ITM, rinse & repeat.
– Robert
I forgot to include buying the put option if you reach 100 shares. Another variation is to only buy 50 shares, then accepting the risk of getting into 50 shares short position if you allow call to expire ITM. When you also buy the put, that creates an open risk graph to the downside (i.e., no loss on price drop).