Top 3 Safest Option Strategies For Beginners (Part 2)

In Part 1, you’ve learned about the Cash Secured Put and why it’s a safe and fantastic Option strategy to use, especially for beginners.

That’s how you can generate a consistent income selling Put Options, while buying your favorite stock at a discount.

If you’ve yet to read Part 1, you can do so by clicking here: Top 3 Safes Option Strategies For Beginners (Part 1)

In this Part 2, I will share with you two more Option strategies that are safe, and can help you be profitable even when the market is dropping.

Let’s get started.

Safe Option Strategies #2: Bear Put Spread

The Bear Put Spread is also commonly known as a Debit Vertical Spread.

And the reason there’s a “Bear” in its name is that this is a Bearish Option strategy where we want the market to go down.

Unlike the Cash Secured Put where we receive money for selling the Put Option, we have to pay money to buy the Bear Put Spread.

That’s because the Bear Put Spread consists of buying an At-The-Money (ATM) Put and selling an Out-of-The-Money (OTM) Put Option.

This is what is called the Long leg and the Short leg.

Thus making the “spread”.

And since the ATM Put Option always costs more than an OTM Put Option, it will always be routed for a debit.

If you take a look at the Option Chain above, you will see that these are all the different strike prices of the Put Option.

The Put Option with the strike price of 101 (in the green box) has a delta of -0.47 which is considered slightly OTM or ATM.

This will be the Long leg.

The Put Option with the strike price of 95 (in the red box) has a delta of -0.29 which is considered OTM.

This will be the Short leg.

When buying a Bear Put Spread, we want the Long leg to either be slightly In-The-Money (ITM), ATM, or slightly OTM.

And for the Short leg, we only want it to be OTM.

For this Long leg, we can buy it at the Mark of $4.625 (which is the mid-price of the Bid and Ask).

And for the Short leg, we can sell it at the Mark of $2.445.

Therefore the net cost for the Bear Put Spread is:

$4.625 – $2.445 = $2.18

In other words, this Bear Put Spread would cost us $218 per Option contract.

This would also be our max loss if the trade went against us.

Now that we know how much this Bear Put Spread costs, how much can we make from it?

If you take a look at the profit & loss graph above, you can see that the max profit we can make on this Bear Put Spread is $382.

If the stock is below $95 (which is the strike price of our short leg) at expiration, we will make the max profit of $382.

And if the stock is above $101 (which is the strike price of our long leg) at expiration, we will lose the max loss of $218.

Anywhere in-between those two strikes will either be a profit or loss as reflected in the profit & loss graph above.

If you noticed, this is not one of those “unlimited loss” Option strategies.

Hence, it’s a safe Option strategy.

And as long as you have proper money management, there’s no way that the Bear Put Spread can wipe out your trading account in just one trade!

Now, if we take the max loss against the max profit, we can see that the risk-to-reward ratio is about 1:1.75.

That means for every $1 we risk, we get to potentially make $1.75.

This also means that even if we just have a win rate of 50%, we would be profitable in the long run!

Don’t believe me?

Let me illustrate with a simple game.

Let’s say we play a game of heads and tails by flipping a coin.

Each time you get heads, you win $1.75.

And each time you get tails, you lose $1.

So after flipping the coin 10 times, this is the result:

1. Heads: +$1.75
2. Heads: +$1.75
3. Tails: -$1.00
4. Tails: -$1.00
5. Heads: +$1.75
6. Heads: +$1.75
7. Tails: -$1.00
8. Tails: -$1.00
9. Heads: +$1.75
10. Heads: +$1.75

So as you can see, there is a total of 5 heads and 5 tails.

That is a 50 percent win rate!

Let’s tally up the amount:

(5 x $1.75) – (5 x $1.00) = $3.75

As you can see, altogether you have won $3.75!

So if people tell you that you need a high win rate to make money trading Options, you know that they don’t know this secret!

When To Use The Bear Put Spread

Now that you know what is a Bear Put Spread, when should you use it?

The best time to use it is when the market is in a downtrend.

The chart above shows the S&P 500 ETF (SPY) in a downtrend.

You can tell that it is in a downtrend because it has made lower lows and lower highs.

On the other hand, an uptrend is when the market is making higher lows and higher highs.

And since SPY is in a downtrend, it’s a good time to enter into a Bear Put Spread trade.

So how do we decide the time to enter the trade?

For this, we want to take a look at the Stochastic Oscillator.

If you take a look at the chart above again, you will notice that at the bottom of the chart you can see this squiggly light blue line and two yellow lines.

That is the Stochastic Oscillator.

What it does is that it gives an indication as to whether the market is Overbought or Oversold.

It indicates that the market is Overbought when the light blue line goes over the yellow line at the top.

And it indicates the that market is Oversold when the light blue line goes below the yellow line at the bottom.

So what we’re looking for is when the market is in the Overbought area.

In the above image, you can see that the Stochastic Oscillator has briefly gone over the top yellow line, and at the same time, SPY has also hit a dynamic resistance which is the Moving Average.

This is a good time to get into a Bear Put Spread as there’s a higher probability that the market will go down than it is to go up.

In the chart above, you will notice that for each of the three times the Stochastic Oscillator is showing an Overbought signal, the market subsequently went lower.

So if you had bought a Bear Put Spread each time the Stochastic Oscillator indicated that the market is Overbought, you would have made money on all of them!

That goes to show that the Stochastic Oscillator is pretty accurate in identifying when the market will go down in a downtrend.

Now, one thing to understand is that the Stochastic Oscillator is not always 100 percent correct.

There are times when the Stochastic Oscillator will indicate that the market is Overbought, but the market still continues to climb higher.

There are also times when the Stochastic Oscillator will indicate that the market is Oversold, but the market still continues to drop.

At the end of the day, it’s all about probabilities.

So you certainly do not want to risk all your money just on one trade!

Also, to have an even higher probability of knowing whether the market is going down, you don’t want to rely just on the Stochastic Oscillator alone.

Instead, you want to find a confluence of Bearish indications using a combination of:

• Bearish price action (lower lows and lower highs)
• Bearish candlestick patterns (bearish pin bar, bearish engulfing candlestick pattern, etc.)
• Stochastic Oscillator
• Dynamic resistance from the Moving Average

When they all indicate that the market has a higher probability of it going down, that’s when you want to enter the Bear Put Spread.

Safe Option Strategies #3: Put Ratio Spread

Last but not least, the third Safe Option Strategy, and the one I like the most, is the Put Ratio Spread.

The Put Ratio Spread may sound very intimidating and complex, but it really isn’t!

In fact, the Put Ratio Spread is simply the combination of the two safe Option strategies that you’ve already learned!

The Put Ratio Spread in essence is the:

• Bear Put Spread
• Cash Secured Put

When you combine these two Option strategies together, you get to profit when the market goes down.

And you get to profit again when the market subsequently goes back up!

The idea here is to use the credit received from the Cash Secured Put to finance the purchase of the Bear Put Spread.

For example, in the image above, you will see that the Bear Put Spread has a debit of $2.18.

But the Cash Secured Put would get a credit of $2.44.

That means that the credit we receive from the Cash Secured Put would more than cover the purchase of the Bear Put Spread.

And when you combine the two together, we get a Put Ratio Spread with a net credit of $0.26.

That means we get $26 for selling the Put Ratio Spread.

Now, the reason it’s called a “Ratio” spread is because of the ratio between the Long and Short Options.

If you take a look again at the image of the Put Ratio Spread, you will see that there is a “Buy +1” and “Sell -2”.

This means overall we bought 1 Put Option and sold 2 Put Options to create this spread.

So 1:2 is the ratio.

This ratio can be changed in any way you like, as long there are more Short Options than Long Options to ensure the spread is routed for a credit.

So it can be 1:3, or 2:3, or whatever makes sense.

But in general, we only want to stick to the standard 1:2 because it makes things simpler for us.

And Options are already complex enough.

So there’s no point making it even more complex than it already is!

How To Trade The Put Ratio Spread?

The way we will be using the Put Ratio Spread is a two-pronged strategy.

That means we have two objectives that we want to achieve:

• Get the max profit on the Bear Put Spread
• Get Long 100 shares on the Cash Secured Put

This will happen together when the underlying stock is below our Cash Secured Put strike price at expiration.

Let me give you an example.

Let’s say you want to buy 100 shares of Nike (Ticker: NKE).

Right now, Nike is trading at $101.18 and you want to only buy Nike when it drops to $95.

So you sell a Put Ratio Spread which consists of the following:

• Bear Put Spread with the strike price of 101/95
• Cash Secured Put with the strike price of 95

And for selling this Put Ratio Spread, you receive a credit of $0.26.

Now, there are 3 scenarios that can happen.

Scenario 1: Nike is above $101 at expiration

If Nike is above $101 at expiration, then the whole Put Ratio Spread expires worthless.

And you get to keep the credit of $0.26.

That is $26 in premium received.

Then you can sell another Put Ratio Spread again.

Scenario 2: Nike is in-between $101 and $95 at expiration

If Nike is in-between $101 and $95, then you take profit on the Bear Put Spread.

And the Cash Secured Put expires worthless.

And you also get to keep the credit of $0.26.

Now, the profit on the overall position depends on where Nike is at.

For example, if Nike closes at $98 at expiration, then the overall profit is:

[$0.26 + ($101 – 98)] x 100 shares = $326

If Nike closes at $96 at expiration, then the overall profit is:

[$0.26 + ($101 – 96)] x 100 shares = $526

As long as Nike is below $101 at expiration, it’s a profit for you.

Scenario 3: Nike is below $95 at expiration

If Nike is below $95 at expiration, then you will take the full profit of the Bear Put Spread.

And your Cash Secured Put will also be exercised.

That means you will be assigned 100 shares at $95.

So the total profit on the Put Ratio Spread would be:

[$0.26 + ($101 – 95)] x 100 shares = $626

Now, let’s calculate the effective cost price that you paid for the shares.

Since you were assigned 100 shares at $95, the cost for that would be:

$95 x 100 shares = $9,500

But because you made $626 from our Put Ratio Spread, it would be subtracted off the cost of the shares:

$9,500 – $626 = $8,874

That means the effective cost price for your shares is $88.74!

That’s a 6.6 percent discount compared to if you were to just buy 100 shares outright at $95!

And that is why the Put Ratio Spread is such a fantastic Option strategy to get Long stocks!

Conclusion

Here are the Top 3 Safest Option Strategies again:

• Cash Secured Put – You sell a Put Option and receive a premium. And you have the cash to fulfill the obligation of buying 100 shares of the underlying stock at the strike price if your Put Option is exercised.
• Bear Put Spread – A two-legged Option strategy where you buy an ATM Put Option and sell an OTM Put Option, to profit from a down move in the underlying stock.
• Put Ratio Spread – An Option strategy that combines both the Bear Put Spread and the Cash Secured Put. A fantastic way to get Long stock at a huge discount.

So when do you want to use each of these?

You want to use the Cash Secured Put when you want to get “paid” while waiting to get your stock filled at your desired price.

And if the Cash Secured Put expires worthless, all you have to do is to sell another one to collect more premium!

That’s how you get an “income” selling Options.

As for the Bear Put Spread, you want to use it only when you want to profit on a down move of the stock.

And to identify that, you can use the Stochastic Oscillator to identify when the stock is Overbought.

Finally, with the Put Ratio Spread, you get the best of both the above Option strategies.

You make money on the way down.

And you get filled 100 shares of the stock at your desired price at a discount compared to buying stocks outright.

Now that you know the 3 safest Option strategies to use, which will you use first?

Let me know in the comments below!