By George Windsor
Renowned investor Warren Buffett once stated that, on average, stock markets rise on two out of every three days. And while that is great news if you own stocks, you might be wondering how do you bet against the market when it falls?
In practice, the market doesn’t rise every two days and fall every third day. If only it were so predictable! Instead, it may go on a winning streak, climbing for many days in a row before plummeting lower for a few days.
It is during these periods when the market is correcting lower that buying puts can be a powerful options strategy to preserve wealth accumulated during up days and even profit during the gloomy, down days.
Some of the richest investors of all time have made fortunes by betting against the stock market, so you will definitely want to get to grips with how to win when markets fall.
You may not end up featured in a Hollywood movie like Michael Burry, who famously bet against the stock market and made a fortune during the 2008-09 crash. But even if you don’t make so much money as to be featured in your own version of The Big Short, you can still arm yourself with the tools needed to stay afloat and even prosper when markets fall.
In practice, dozens of strategies exist to bet against the market, but for now let’s share perhaps the simplest one: buying puts.
What Is A Put Option?
If you are new to options trading, you might be wondering what is a put option?
In a nutshell, a put is a contract that gives you the right to sell stock at a fixed price for a certain time period.
For example, if you owned 100 shares of Netflix stock and purchased a put option contract that expired 6 months from now, you would have the right to sell your stock at a fixed price anytime between now and then.
Even if Netflix crashed to zero during that time frame, you would still have the right to sell your stock for the agreed upon price!
And the good news is the power of put options doesn’t stop there.
You don’t even need to own a stock to make money with put options. You could simply buy a put option and sell it later when a stock falls without ever owning a dime’s worth of the company’s shares.
Buying Puts vs Shorting Stock
If you’ve been around the stock market for a while, you have probably heard of the term: shorting stock.
When traders believe a stock will fall lower, they can borrow shares and sell them with a view to buying them at lower prices later on. That process is known as shorting stock and is a way to bet against a company’s stock.
To bet against Alphabet stock, for example, you would short Alphabet at the current share price in the hopes that, when the price fell, you could buy it back (buy-to-cover is the terminology used) for a profit.
The kicker is if you are wrong, you risk losing a lot of money. In fact, the higher the share price goes the more you lose when shorting stock.
So when making a choice between buying puts vs shorting stock, the former is often preferred because the risk is limited. In fact, the most you can lose when buying puts is the amount you pay for the puts.
How To Buy A Put: Profit When Stocks Fall
Most good brokers these days can handle trading requests to buy put options but if you want a combination of knowledgeable support staff, competitive commissions costs, and fast order execution, the best options brokers are your best bet.
Whether you are a newbie or an experienced options trader, these trading platforms have the tools, education, and trading communities to get you started on the right track to buy your first put option contracts.
Buying Puts Example
Each put purchase begins with a Buy to Open order. For example, if you are betting against XYZ stock, you could buy to open 1 put contract of XYZ at strike 75 for say the month of January.
Let’s pretend it costs you $2 to purchase the put option and by January’s option expiration date XYZ shares are priced at $65.
Your put contract would be worth $10 now, the difference between the strike price, $75, and the share price, $65.