You don’t have to lose money in a down stock market and there are ways to make money. But it is riskier then the buy and hold method of investing. This wouldn’t be called investing it is trading. You can’t just buy these options and funds and forget about them, they need to be watched carefully.
Buying put options
Options are much riskier than owning stocks or mutual funds or ETFs (Exchange Traded Funds). And there are many option strategies, too many to go into here. The simplest way to make money using options in a down market, is to buy put options. Buying a put option gives you the right but not the obligation to buy a certain stock at a certain price within a certain time frame. But most people never do buy the stock they just trade the options. You buy put options when you believe a stock or index is going to go down, the put option will increase in price as the stock or index goes down.
For example, you believe the S&P100 (symbol OEX) is going to go down. You can then buy OEX puts. You could buy 10 OEX January 2009 puts at $3 per option. Each option represents 100 shares. That costs you $3000. And these options would expire on the third Friday of January 2009. If the S&P100 did go down as you thought it would, these options would increase in price. And you could sell them for a profit. For example if by the first week of January the market had really dropped and these options increased to $5 per option, you would then sell them at that time for $5000, making a nice profit.
The math: Buy 10 puts at $3 per option. Each option represents 100 shares of the stock or index. 10 puts x 100 shares = 1000 shares at $3 per = $3000. Many stock options don’t cost as much as this example either.
Options have a finite life, and time is against them. The closer you get to the expiration date of any option they lose time value. If the OEX didn’t go down at all or even went up by the expiration date, your options would expire worthless and you would lose your original $3000.
With put options, you can speculate on individual stocks going down or an entire sector or the whole market. There are many options for stocks and indexes to buy, when you see a quote for a stock or index, look for the option chain. That will show you all the options for that stock or index.
Inverse ETF
Exchange traded funds (ETF) are like mutual funds but different. They are the same in that these funds also hold many different companies in their funds. They differ in the fact that they can be traded during the day, you can see its price change during the day. If you want to own all of the DJIA 30 stocks, well you could with some of these ETFs.
An inverse ETF is a fund that goes up when the market goes down or when a certain index or sector of the market goes down. Instead of buying put options, you would buy one of these inverse ETFs. For example, you believe the DJIA is going to go down, you would buy the ETF with the symbol of DXD.
If you thought that the banks were going to go down some more, you could buy the ETF with the symbol of SKS.
If you thought that the Nasdaq was going down on a certain day, you could buy the QID. If the market or sector of the market went down and you had bought one of these inverse ETFs, you would have made money.
Today more and more of these exchange traded funds are becoming available. One important fact about them, stick to the ones that have decent volume. The good thing about ETFs compared to put options is that they don’t expire, you can hold them for as long as you want or need to. It would be very unlikely that you would lose all of your money with an ETF like you easily could with options.
Other strategies
Shorting the market or a stock is another way to make money in a falling market, but this requires you to have a margin account with your broker. And these can be more risky.
Selling or writing call options, these are even more risky and they also require a margin account. You would be selling call options to people in the belief that the market either moves sideways or goes down, that way you make the money on the call options you sold. But if the market were to go up, you could lose a lot of money on the call options you sold, you could lose a lot more money then you took in when you sold these call options. There are books written solely with different option strategies, you should study them before even trying to write options.
Books and web sites:
Getting Started in Options by Michael Thomsett
Winning With Options by Michael Thomsett
Trade Your Way to Wealth by Bill Kraft
Sam Montana © 15 December 2008
