In recent days, the market has spiked off the August lows and many stocks have recovered nicely. However, there is no certainty that this rally will hold. If I had a large portfolio, in this type of situation, I might sell an out-of-the-money Bear Call Spread in the S&P 500 ETF (SPY).
This strategy involves the selling of a call at a lower strike price, while simultaneously buying a call at a higher strike price. The maximum profit on this strategy is the premium you collect. The maximum loss is the difference between the strikes, minus the premium you collect.
Here is an example:
Let’s say stock XYZ is trading at 90. You could theoretically sell the 100/105 bear call spread for $1. To execute this trade, you would:
Sell the 100 calls,
Buy the 105 calls,
For a total credit of $1.
Here is the graph of this trade at expiration.
As you can see, as long as the stock stays below 100 by expiration, you will collect the $1 in premium, or $100 per spread sold. If the stock goes to 105 or above, your losses are capped at $4, or $400 per spread sold.
This is a strategy that I always have in my personal portfolio. I am long enough stocks that if I sell an out-of-the-money call spread, perhaps 5%-6% out-of-the-money, I would be thrilled if I lost on this spread because my other positions would have gained 5%-6% along the way.
Jacob Mintz is a professional options trader and chief analyst of Cabot Options Trader and Cabot Options Trader Pro. Using his proprietary options scans, Jacob creates and manages positions in equities based on risk/reward and volatility expectations. Jacob developed his proprietary risk management system during his years as an options market maker at a top-tier options trading company in Chicago.