Options for bear market ( pun intended.. )

[spindr0]

Trying to guess where a falling market will bottom is tricky... No one has a crystal ball, but there are times when it is less risky to have market exposure than others. .

In 2000 it took two plus years to go from top to bottom and in 2008, it took 18 months to go from the top to the bottom (both down 50+ pct). You don't have to determine the magnitude of the drop or guess when it will end. You recognize market deterioration, you take your short position and you manage it.

Downturns such as 1987, the 2000 Dotcom Bust, and the 2008 subprime melt down did not happen overnight. For those who aren't oblivious, in such events, at some point it becomes obvious that metrics are deteriorating - economic indicators turn down, earnings announcement disappointments increase, analyst downgrades and earnings revisions increase, the VIX increases, all beginning long before the crisis becomes acute.

Transitioning to cash or quality debt is something that any experienced investor can achieve. If god forbid one takes off the 'long only' tunnel vision blinders, one can even go short a small position and transition to more short as the market drops further. For investors, let the portfolio’s declining value dictate the transition from long to short (and vice versa).

Trying to guess when a bear will start or end is a fool's errand. React, don’t predict.

If you want to play a drop, I'd suggest taking advantage of the high IV by selling a put spread if you think the drop will reverse or call spread if you think it will continue. That way, even if the market goes sideways for a while, you can still make money.

If IV is high and you want to play a drop, sell bullish call spreads.

 

[ajacobson]

Simulated VIX from OEX midpoints at the 87 break calculated out to about 150 volatility. Lot's of noise in that number and markets weren't really continuous - so the number has a lot of noise, but it was ugly.

 

[STD Deviant]

The craziest implied volatility that I have seen was the crash of '87. Much of that was artificial since B/A spreads were Holland Tunnel wide and you couldn't transact since the haircut was more like using a guillotine.

At that time, I didn't know enough then to take advantage of it, so I just just about ate every short put position that I sold on expiration Friday, the day before the crash (assigned and bought all of the stocks). Fortunately, it ended up being a flat year so the damage was fairly short lived.

In a bear you want to be long puts whether it be outright long or in combo strategies like verticals, diagonals, etc. As your long puts appreciate, roll them (or the combo) down and possibly out, booking gains and reducing exposure. Pyramid them a bit if you're succeeding. With the combos, to some some extent, what you overpay for your longs (higher IV) will be offset by your shorts.

It doesn't address your question but in 2008-2009, in order to take advantage of the severe volatility, I ran a long/short correlation portfolio for myself, shifting more L or S intraday and restoring my desired ratio by 4 PM. It provided outsized gains, the likes of which I never saw before or since. Now, I feel like the Maytag repairman, waiting for another call like that one.

Would you be so kind as to give a man an example? Would this be like buying puts and selling Bear Call spreads to lower cost basis (or perhaps Bear Put spreads)? Perhaps there's a link that describes the philosophy?

Thanks!

 

[srinir]

Downturns such as 1987, the 2000 Dotcom Bust, and the 2008 subprime melt down did not happen overnight. For those who aren't oblivious, in such events, at some point it becomes obvious that metrics are deteriorating - economic indicators turn down, earnings announcement disappointments increase, analyst downgrades and earnings revisions increase, the VIX increases, all beginning long before the crisis becomes acute.

Excellent point.

Economic indicators did indeed turned down long before recession.

 

[srinir]

Trying to guess when a bear will start or end is a fool's errand. React, don’t predict.

Another good point. Realized volatility picks up during any down turn. If one is using leverage, they should reduce leverage. Risk parity and CTA's also target volatility, traders should also imo. If they are using leverage of 2 when realized vol is at 10, then leverage should be reduced to 1 the realized vol is 20. Examples of realized vol picking up long before recession.

 

[spindr0]

Would you be so kind as to give a man an example? Would this be like buying puts and selling Bear Call spreads to lower cost basis (or perhaps Bear Put spreads)? Perhaps there's a link that describes the philosophy?

Sorry, my bad. The long/short correlation portfolio was with financial stocks (not options) which were being hammered during the GFC melt down. My option comments applied to defending a collapsing combo such as a bull put spread.

 

[srinir]

Would you be so kind as to give a man an example? Would this be like buying puts and selling Bear Call spreads to lower cost basis (or perhaps Bear Put spreads)? Perhaps there's a link that describes the philosophy?

Thanks!

I recommend this book which i read recently.

 

[TrustyJules]

In 2000 it took two plus years to go from top to bottom and in 2008, it took 18 months to go from the top to the bottom (both down 50+ pct).

+1 on that one. Bear markets are much shorter than bull markets. The first investment book I ever read was Peter Lynch's one up on Wallstreet of 1989. He makes the same point there only excluding the early 1970ies bearmarket which was longer. Having lived through everything since 1985 I can pretty much confirm that from a personal experience perspective. When you adapt option strategies to the bear market its fortunate 'markets do not fall up' but beware the bear period is always shorter than the media make it appear.