Are we in a Bear Market?
Updated: Nov 9, 2022
Risk management is critical when we are in a bear market.
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What is a bear market?
A bear market is defined as a -20% drop from recent highs in the stock market. Therefore, we are in a technical bear market in 2022.
Selling OTM put options on the S&P 500
Many traditional investors invest their money into an S&P 500 index fund like VOO or SPY. I prefer to sell put options on the S&P 500 because it can outperform the index with better risk-adjusted returns according to backtests.
- Selling 90 DTE -.15 delta put options on /MES futures
My current strategy involves selling puts on /MES futures that expire in about 90 days using the -.15 delta strike price. Depending on your account size, you can use the SPX, SPY, /MES, or /ES. Many option sellers like to trade 45 DTE options, but when you go further out in time, the -.15 delta strike is further away from the current spot price.
Using 90 DTE options allows you to sell a lower strike at the same delta and collect more premium than shorter-dated options. The lower strike selection reduces your gamma risk, and collecting more premium per contract decreases the amount you spend on commissions. 90 DTE options also require much less management than shorter-dated options since the trades will be open longer.
- Managing risk
Selling put options on the S&P 500 index can be risky without a proper risk management strategy. Option selling has much more downside potential than upside. Therefore, it is crucial that you use stop losses.
Another way to manage your risk is to buy tail risk hedges on the S&P 500 index.
- Positive EV options strategies
Additionally, you need a system with positive expected value (EV). A positive EV trade plan means that the win rate and profit or loss per trade add up to a positive PnL.
For example, if you use a stop loss at -$100 and take profit at +$100, you would need your system to win just over 50% of the time to have positive EV. If you lose ten trades and win ten, your win rate is 50%. You will have -$1,000 in losses and +$1,000 in profits.
However, if you win 11 trades and lose 9, you have a win rate of 55%. You will have +$1,100 in profits and $-900 in losses and be profitable. You can fix the win and loss size, but backtesting is required to determine the historical win rate.
Dollar-cost averaging into ETFs
When selling options with a margin account, you can keep a lot of your account as cash since you are utilizing leverage. For example, if you have a $100,000 account, you can sell four of the 300 strike put options which command $120,000 of notional value (30,000 * 4 = 120,000).
However, since you have margin, you will only need to put up 20% of this value or about $24,000 (120,000 * 0.20). This means you will have $76,000 worth of buying power left while fully allocated on a notional value basis.
You can use some of this extra buying power to purchase shares of ETFs such as SPY or VOO. However, you mustn’t buy too many shares and overallocate your account. Everybody has a different risk tolerance, so you must determine yours before adding shares into your options account.
Personally, when the market is coming down, I slowly dollar cost average into shares day by day. I generally plan to hold the shares long-term, but depending on where the market is, I will consider selling some shares to reduce my exposure and take profit.
Holding equity and ETFs in my ROTH IRA
Aside from my options account, I have a ROTH IRA where I buy and hold long-term equities. I keep a combination of dividend growth stocks, growth stocks, and ETFs. If you are an index fund investor, you do not need to know how to research the stock market or view stock news.
If I want to reduce my risk due to bad market conditions, I will allocate a higher percentage of my portfolio to ETFs. If I want to take on more risk, I can allocate a higher percentage to single growth stocks.
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