Bear and Correction Market Strategies

Volatility is back!  When such volatility occurs, this can be a tremendous opportunity to grow some short and medium term wealth.  In this article, I will share several strategies to do so.  Please keep in mind that this is not personalized investment advice and I do caution to understand your risk tolerance before executing any of these strategies.

Since the end of December 2017, I was gradually positioning my portfolio in a more defensive posture.  The first shot across the bow occurred in February 2018, where the DJIA lost more than 1,600 points compared to the record high achieved in January 2018.  Some of the reasons for this include spiking bond rates due to the threat of inflation which caused concern that the boost from the Trump tax cuts could potentially force the Federal Reserve to raise interest rates.  Additionally, equity valuations were high and due for a pullback.

In October and November 2018, the second and third shots respectively occurred.  These drops were driven by concerns of rising interest rates, growth slowdown, and global trade tensions.  In particular, the escalating trade conflict between the United States and China is having a direct impact on the predictability of the markets.  Whether this is a correction or the start of a bear market is not the purpose of this article, rather I would like to propose some strategies to profit from the volatility and downward pressure categorized by your risk tolerance.  Also, please have a full understanding of options and inverse ETFs before considering any of these strategies.

• General Advice and Personal Trading Rules
  • Note that no single option trade should risk more than 2% of your portfolio.
  • Get in the habit of cashing out profits to your savings/checking (i.e. safe) accounts as opposed to growing your brokerage account.
  • Take the emotion out of the process.
  • Keep a long term investing time horizon for some of the positions in your portfolio.  However, depending on your risk tolerance, do set stop losses if needed.
• Trading Strategies
  • Keep in mind that in a correction and bear market, the trend is downward, but there are wild and violent swings upwards which soon get faded.
  • The ability to read an intraday (15m, 1h, etc) chart is very useful to capitalize on intraday movements and set entry points for some of the strategies below.
  • High Risk
    • Sell calls against the indices on days where the market rallies.  Selling calls gives you instant income and you can close the position at a gain if timed right.  This is a highly risky strategy and should consider longer expiration dates to increase safety.  Also, monitor your balances to avoid a margin call.
    • Buy 3x leveraged inverse ETFs (e.g. SPXU, SDOW, SQQQ, etc) or 2x leveraged inverse ETFs (e.g. SDS, QID, DXD) when the correction/bear market has a strong rally and sell the position during the next violent downswing.  This strategy has been very effective for me personally during October and November, but keep in mind position sizing and time frames for this strategy as profitability can decay quickly for the inverse ETFs.
    • Execute bear call spread option trades when the market rallies.  Do call spreads where the short call has a 50-75% chance of expiring worthless and the long call can be adjusted to limit the max amount of a potential loss.
    • Short selling key names which are dragging down the market.  Shorting is highly risky, but there are some profitable opportunities.  For example, I have shorted IBM around most earnings releases within the last 2 years and the cumulative profit from this short was in the six figures range.  If one shorted Apple during the past two months at the right times, they would have been rewarded handsomely.
  • Medium Risk
    • Purchase put options on the S&P 500, Nasdaq, and QQQ (or their respective ETFs).  To limit risk, can select expiration dates that are further out.  However, depending on your risk tolerance, can close for profit once it reaches a target of 25-50% gain.  My tolerance and mapping of the market direction gives me comfort to wait for larger gains.
    • Buy 1x inverse ETFs (e.g. SH, PSQ, DOG) when the correction/bear market has a strong rally and close the position when appropriate.  Keep position sizing in mind.
    • Execute bear call spread option trades when the market rallies.  Do call spreads where the short call has a 80-85% chance of expiring worthless and the long call can be adjusted to limit the max amount of a potential loss.
  • Low Risk
    • If not done already, restructure portfolio towards lower beta and “safer” positions.  This includes Treasuries, utilities, certain CEFs, etc.  The key is to select high quality equities with a long history of paying and growing dividends.  Many of these lower beta equities and funds also pay a nice dividend, so you can avoid constantly watching the market and reinvest the dividends at a lower basis until the market switches the preference from value to growth once again.
      • Back in 2008, Treasury ETF TLT produced an annual return of 33.76%.  However, you would have needed to take some profit as the return in 2009 was -21.53%.
    • Increase your cash position and await good buying opportunities for long term positions at favorable valuations.  This includes blue chip companies like Microsoft, Amazon, and Johnson & Johnson.  Keep a watch list of certain stocks and you can use your brokerage account to set price alerts so you can trade without constantly watching the market.
    • Execute bear call spread option trades when the market rallies.  Do call spreads where the short call has a 90-95+% chance of expiring worthless and the long call can be adjusted to limit the max amount of a potential loss.  This can provide you a weekly income stream while the market is correcting.

Of course, there are other strategies that can be taken to profit in this environment, however these are some that I have used effectively this year to navigate the current markets.  Good luck to all and happy trading!

-Jonathan Ozovek