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Shorting a Stock: A Viable Bear-Market Strategy?

Our approach to covered call writing and put-selling in bear markets include an arsenal of trading concepts that will enhance our opportunities for successful outcomes. These include:

  • Use of deep in-the-money calls
  • Use of deep out-of-the-money puts
  • Use of lower implied volatility securities
  • Use of low-beta stocks
  • Use of exchange-traded funds
  • Lowering our time value return goals during the bear market environment
  • Use of appropriate position management bear-market techniques
  • Use of inverse exchange-traded funds in confirmed bear markets

Some of our members have asked about shorting stocks as an alternative strategy during these bear markets and this article is dedicated to a discussion of this approach.

 

What is shorting a stock?

This when an investor sells a stock not currently owned and therefore needs to be borrowed before selling. The expectation is for the share value to decline so it can be repurchased at a lower price and therefore generate a profit. The stock is generally borrowed from a broker’s inventory and there will be a lending or interest fee. The short sale will result in a cash deposit into the investor’s account. Eventually the shares are re-purchased at market and returned to the lending broker. The profit or loss will be determined by the price the shares are repurchased. The chart below summarizes the process:

 

bear market strategies

Short-selling a Stock

Note: Short-selling cannot be used with penny stocks and must be sold in round lots (100 share increments)

 

Why are there short-sellers?

Speculating: Investors speculating that there will be a share price decline

Hedging: Protecting long positions in the same vein that portfolio managers may aspire to achieve Delta-neutral portfolios… a long position is Delta-positive and a short position is Delta-negative

 

Risks

  • Stock markets have upward bias…short-selling is like running uphill
  • Losses are potentially unlimited (stock price can go as high as infinity) but gains are limited (stock price cannot go below zero). Use of buy stop-loss orders are critical
  • May be exposed to margin call since borrowing shares mean margin trading. We may be required to add cash to our account or liquidate positions
  • A short squeeze (short-sellers covering positions) can cause stock price to accelerate exponentially
  • Short-sellers may be required to pay dividends to the stock lenders (best to short sell a stock that pays no dividends)

 

Discussion

Shorting a stock is a bear-market strategy that may be appropriate for some sophisticated investors with a high risk-tolerance. For most retail investors, in my humble opinion, there are better, less speculative, approaches to bear market scenarios which I enumerated in the first paragraph of this article.

 

Upcoming speaking event

Orlando Money Show: February 8th –  11th, 2018

Click for information

Thursday, Feb 8, 2018
09:00 AM – 09:45 AM 
All Stars of Options
“How to Select the Best Options for Covered Call Writing in Bull and Bear Markets”

 

Friday, Feb 9, 2018
12:15 PM – 03:15 PM
Premium Master Classes (Paid event to Money Show)
“Basics of Options Trading Using Covered-Call Writing with Pro-Active workshop”

Friday, Feb 9, 2018 06:30 PM – 07:00 PM
Stage presentation
“Covered Call Writing with Dow 30 and S&P 500 Stocks”

 

New speaking event just added

Las Vegas Money Show

Bally’s/Paris Hotel

Monday May 14th

11 AM – 12 PM

 

Market tone

 This week’s economic news of importance:

  • Industrial production Dec 0.09% (above expectations)
  • Weekly jobless claims for week ending 1/13 220,000 (below expectations)
  • Housing starts Dec 1.192 million (below expectations)
  • Building permits Dec 1.302 million
  • Consumer sentiment Jan 94.4 (below expectations)

 

THE WEEK AHEAD

Mon Jan 22nd

  • Chicago Fed national activity index Dec

Tue Jan 23rd

  • None scheduled.

Wed Jan 24th

  • Markit manufacturing PMI Jan
  • Markit services PMI Jan
  • Existing home sales Dec

Thu Jan 25th

  • Weekly jobless claims for week ending 1/20/18
  • New home sales Dec
  • Leading economic indicators Dec

Fri Jan 26th

  • GDP Q4
  • Durable goods orders Dec

 

For the week, the S&P 500 rose by 0.86% for a year-to-date return of 5.11%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Buy signal since market close of August 31, 2017

BCI: I have a short-term bullish approach to the market, selling 2 out-of-the-money strikes for every 1 in-the-money strike. 

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a slightly bullish outlook. In the past six months, the S&P 500 was up 15% while the VIX (11.20) moved up by 15% but still historically low.

Wishing you much success,

Alan and the BCI team

 

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

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21 Responses to “Shorting a Stock: A Viable Bear-Market Strategy?”

  1. Jay January 20, 2018 10:38 am #

    Good morning friends,

    If I make my point quickly and hit send I may be the first comment on this week’s thread :)!

    I don’t know enough about what happens behind closed doors up in D.C. to play the “blame game” on the shutdown, But I do care about how the market reacts. If there is a sell off Monday it will be a great time to buy some things.

    I will wait well into the week before covering anything for the new expiry since any sell off will likely be short lived and a pop will occur. I have been to this rodeo before :)! – Jay

    • Hoyt T January 20, 2018 9:06 pm #

      This is not my first rodeo either and probably not for most BCIers.

      While this (the shutdown) shouldn’t be negative for the markets it can be very negative for small business people particularly operators around government facilities and national parks, restaurant owners, motel owners, service providers, etc.

      I am trying to attach a jpeg. Don”t know where it will end up so this is test.

      Happy trading,
      Hoyt

      • Hoyt T January 20, 2018 9:09 pm #

        Obviously the jpeg didn’t do what I had intended.

        Does anyone know how I get a photo of me under my name?

        Hoyt

      • MarioG January 21, 2018 4:08 am #

        Nice photo, Hoyt….

        Maybe I will get out my Charlie 1 Horse hat and send it in!

        Sandy and I recently used it to a Scooting Boogie dance at a local Community Center dance. Bought it in 1990 in Davie, FL. just south of Tamarac, where we are located.

        Mario

      • Jay January 21, 2018 2:47 pm #

        Hoyt,

        A long time ago when i was flying in the Army Air Cavalry we wore black Stetsons with gold braid at formal functions! I suspect they still might…..

        I am looking forward to the open in the morning and seeing how the “Trump/Schumer Shut Down” plays out. It is silly that spinning political blame has now eclipsed resolving the issues for both sides.

        You make good points about the collateral damage these events do. If this clip from Yahoo Finance this morning is any measure the market impact may be minimal and brief:

        That calm prevailed as signs of a deadlock gathered shows how desensitized investors have become to political wrangling. And why not? In 18 shutdowns over the past 42 years, the median return of the S&P 500 has been 0 percent, according to LPL Financial Research.

        “Although a government shutdown sounds scary, the reality is it has been a non-event historically for equities,” LPL’s Ryan Detrick wrote in a note to investors last year.

        In the most recent example, in October 2013, the S&P 500 slumped 2 percent in the immediate aftermath before reversing to rise 1.8 percent by the time a stop-gap bill was signed. Bonds likewise shrugged off the issue, with 10-year yields adding just five basis points during that span.

        “In the past if we’ve had a 2 or 3 day shutdown, it hasn’t meant anything,” Scot Lance, managing director at California-based Titus Wealth Management, said by phone Saturday. “If there’s a dip, buy it.”

        I have my shopping list ready :)! – Jay

  2. Barry B January 20, 2018 7:27 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 01/19/18.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,

    Barry and The Blue Collar Investor Team

    barry@thebluecollarinvestor.com

    • MarioG January 21, 2018 3:51 am #

      Barry,

      Looks like SCHW ER should be 4/18/18, not 1/17/18.

      Looks like TEAM ER should be 4/19/18, not 1/18/18.

      Glad to help.

      Mario

  3. Ed January 21, 2018 11:21 am #

    Allan, have you ever used any other stock lists other than IBD? Have you ever tried value stocks as opposed to momentum?

    • Alan Ellman January 21, 2018 2:20 pm #

      Ed,

      At BCI, we only use our own screening process. For stocks, the screening includes fundamental, technical and common sense parameters. Part of the fundamental screening we do use the IBD SmartSelect screen but this is only a small part of the entire process. We also always include the IBD 50 in addition to our database of over 3000 stocks as a resource to start our weekly screening process.

      Our members receive 3 reports which include our weekly stock and ETF reports and our monthly Blue Chip reports (Dow 30). Members can select based on portfolio goals and personal risk-tolerance.

      Alan

  4. Barry B January 21, 2018 3:43 pm #

    Premium Members,

    The Weekly Report for 01/19/18 has been revised and uploaded to the Premium Member website. The revision was due to two typos in ER Dates. There were two stocks that are now eligible for trading in the 02/16/18 option cycle. They are SCHW (ER Date 4/18/18) and TEAM (ER Date 4/19/18).

    Thank you Mario.

    Best,

    Barry and The Blue Collar Investor Team

    barry@thebluecollarinvestor.com

  5. roni January 21, 2018 3:49 pm #

    Expiry weekend report:

    This cycle was very favorable for me, recovering my last month losses. 🙂

    My total account value is up 6.7%, but when factoring last cycle loss of 1.8%, the average for the two months period is 2.4%.

    If you remember, I had 7 losers last month. I did hold all of them because I was unable to choose the good from the bad.
    This tactic worked well, due mainly for the rally, and some positions management.
    I am still holding CGNX, which recovered above my BEP.
    All the others were sold or assigned last Friday.

    Today I am 70% in cash, and ready for action.

    Roni

    • MarioG January 21, 2018 5:09 pm #

      Very good Roni, glad you are up for this month and your average is good as well. Yes holding on to a stock to see if it recovers to at least the BEP or better is a good strategy to try. I have done that many times successfully.

      My performance was good as well. I posted the results through 1/18/19 in a post early last Friday.

      Mario

      • roni January 22, 2018 9:17 am #

        Thank you Mario,

        I read your 1/18/19 post today and congratulate you, as always you do an excelent job.
        I was unable to read it before, due to moving to an apartment.

        Roni

    • Jay January 21, 2018 6:40 pm #

      Congrats an a well managed expiry, Roni! Nicely done….

      You know my time frame is longer than yours. I split my buys and my over writes. I don’t keep score month to month. We all have nuances on how we play this game. But we share the same goals: make money and beat SPY!

      It would be ludicrous of me to ever “hope” the market goes down. I never do that. But I bought a few ITM puts on SVXY, SPY and QQQ Friday as a hedge for tomorrow. I hope they work so I can finance some fun things quickly :). But it will not hurt me if they don’t because I am invested long everywhere else.

      And, like you, I have dry powder ready for action! Yet I will not use it all tomorrow should buying opportunities present themselves.This is not your typical first week of a new expiry.

      The way the political football bounces up here in the US is likely to have a larger than normal ripple effect. – Jay

      • roni January 22, 2018 9:20 am #

        Thank you Jay,

        I agree with your assesment of the political situation. Let’s wait and see before placing our new trades.

        Roni

        • Jay January 22, 2018 10:58 am #

          Well, Roni, looks like I am becoming a skilled contrary indicator and my small amount of put protection was not needed! My accounts are up nicely today and this shutdown is apparently a yawner from a market perspective. People see positive fundamentals and have not over reacted. In fact they reacted positively :)?

          I suppose if it drags on that picture could change. The market draw down in 2013 was quick at the outset and that was what I was partially guarding against. – Jay

  6. Ed January 21, 2018 3:57 pm #

    If I understand your screening process, any eligible stock had to pass the IBD screens, ie 6 green circles. From there the additional BCI screens are applied. Currently there are less than 250 stocks that pass the IBD screen. Wouldn’t it be easier to take that list of stocks and then apply the additional screens so you don’t have to really screen 3000 stocks?

    • Alan Ellman January 22, 2018 5:48 am #

      Ed,

      In order to be sure that all stocks in our database that we have identified over the past 10 years as potential short-term option-selling candidates, we prefer to use our database in addition to the IBD 50. The process is a bit tedious but my team, led by Barry Bergman, has the process down to a science and is able to create the stock report in under 15 hours after market close on Friday.

      Alan

  7. Geoff January 21, 2018 6:46 pm #

    As some additional extra-blog information, you need a margin account to short stocks directly. In a bear market, a short of the S&P or Russell or Dow may work well enough but I don’t like to be short broad indices, personally. When I do short, I typically buy an OTM call to cover the risk of a massive gap against myself–it’s cheap insurance. Alternatively, that is the same risk profile as merely buying an ITM put but buying an ITM put is not very flexible and can be unforgiving.

    • Jay January 21, 2018 7:53 pm #

      Welcome back Geoff, long time no see, please do not be such a stranger – I miss your contributions :)! – Jay

  8. Alan Ellman January 22, 2018 7:45 am #

    Premium members:

    The February edition of our Blue Chip (Dow 30) Report has been uploaded to your member site. Look in the “resources/downloads” section on the right side of the member site.

    You will note that there are no new candidates added but 3 of the stocks on last months report were eliminated because they no longer meet the BCI screening criteria.

    This week’s ETF Report will be uploaded to the member site on Tuesday evening.

    Alan

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