There’s an old saying among traders … “fortunes are made in bear markets.”
And this week, as the major indexes are getting demolished, that saying is more timely than ever.
But have you ever wondered how ‘sophisticated investors’ make money hand-over-fist during market crashes … while ordinary, everyday people lose their life savings?!
Well, one of the main reasons this happens is because the ‘smart money’ — a term used to describe institutional investors and hedge funds — knows how to trade put options effectively during market downturns.
Later, I’ll tell you some stories about how famous traders have used puts to their advantage, nailing some of the greatest trades of all time.
But first, let’s talk about why put contracts can be such incredible vehicles for trading bear markets.
Keep reading and I’ll show you what I’m getting at…
Why I Love Trading Put Options
When the market is capitulating to the downside, the trend is your friend. That’s why I’ll be looking for opportunities to trade put options.
Why puts as opposed to shorting common shares?
Two words: defined risk.
I don’t know why anyone would short common shares when the ‘option’ to buy puts is on the table (excuse the pun).
Allow me to explain…
Shorting stock has theoretically unlimited risk. If the stock you’re shorting rips to new all-time highs, you’ll lose more money than you invested in the position.
This can put you at risk of receiving a margin call and blowing your entire account up.
On the other hand, if you buy puts, you can never lose more than your initial principal.
Additionally, put options have considerably more upside on the way down than common-share shorts.
Take it from me. I’ve built an entire trading strategy primarily around trading puts. (If you’d like to learn more about my strategy, check out my brand-new ebook right here.)
Now, let’s look at a hypothetical example of why puts are better than a normal short position…
Say you’re watching Stock XYZ and it’s trading for $100!
If you sell ten shares short, and the stock goes to $0, you could make $1,000 — a 100% gain on your principle.
Not bad, but not great for the amount of risk you’re taking.
But in the same hypothetical, where XYZ goes to $0, put options on any strike price would pay several multiples more than the common-share short. This is why I trade puts…
Bottom line: You can potentially make more money — while simultaneously risking less — on a put position vs. a common short position.
And more than any other time in 2023, you should now consider your put-trading options (excuse the pun).
Real-World Examples of Bear-Market Fortunes
Don’t just take it from me…
Some of the greatest options trades of all time have been made by using puts on red days/weeks:
1987: In one of the most talked-about options trades in history, Paul Tudor Jones called the 1987 market crash before it happened. He bought a ton of puts on the major indexes. Then, on October 19, 1987, the Dow Jones plunged 22% — while Jones bagged approximately $100 million on the trade.
1987: Trader Andy Krieger made a name for himself shorting New Zealand’s dollar, sometimes called the kiwi, as the currency collapsed during the market crash of 1987. The kiwi plummeted as much as 5% while Krieger made $300 million for his employers
2015: Best-selling author (and former full-time options trader) Nassim Nicholas Taleb bought cheap SPY puts and VIX calls as the S&P 500 tanked 8% and the VIX surged 50%. Taleb’s entire portfolio increased by 20% while he profited more than $1 billion in a single day entirely on bearish options contracts.
2018-2020: London-based hedge fund Ruffer Investment Management purchased an eye-popping amount of volatility insurance from 2018 to 2020, then profited $2.6 billion in the pandemic selloff.
Again, there’s a reason why many of the greatest options trades in history were so bearish. Because fortunes are made in bear markets.
Furthermore, I’ve found the same to be true in my trading…
Back in 2021, I nailed my biggest win of all time — an overnight gain of $230,000+ — by trading puts on the ProShares Bitcoin Strategy ETF (NYSEARCA: BITO).
This trade wouldn’t have been possible without using put contracts (and never would’ve happened under normal market conditions).
REMEMBER: Puts + Market Volatility = Potentially HUGE Gains!
In other words, don’t look at a brutal red week in the market and get discouraged. Start looking for the opportunities lying in the wake of the destruction.
Who knows, you might find you nail your biggest trade ever during a bearish period (like I did).
And speaking of nailing excellent trades…
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