Bearish and Bullish Strategies
Now that you understand long and short positions, you can match each strategy to the right market outlook. This section ties together everything from this unit: order types, positions, and risk.
Market Outlook Definitions
- Bullish: expecting the market or a security to rise in price
- Bearish: expecting the market or a security to fall in price
Exam Tip: Gotchas
Do not confuse the outlook with the strategy. Bullish strategies profit when prices rise; bearish strategies profit when prices fall. Some strategies (like selling puts) are bullish despite involving an option sale.
Strategy Summary Table
| Strategy | Market Outlook | Maximum Gain | Maximum Loss |
|---|---|---|---|
| Buy stock (long) | Bullish | Unlimited | Limited to purchase price |
| Short sell stock | Bearish | Limited to sale price | Unlimited |
| Buy call option | Bullish | Unlimited | Limited to premium paid |
| Buy put option | Bearish | Limited (strike price minus premium) | Limited to premium paid |
| Sell (write) call | Bearish/neutral | Limited to premium received | Unlimited (if naked) |
| Sell (write) put | Bullish/neutral | Limited to premium received | Limited (strike price minus premium) |
Exam Tip: Gotchas
A short sale and a naked call both carry unlimited loss potential because the underlying price can rise without bound. Option buyers always have limited loss (only the premium paid).
Bullish Strategies
If you expect prices to rise:
- Buy stock (go long): the most straightforward bullish strategy. You own the stock and profit directly from price increases
- Buy a call option: gives you the right to buy at the strike price. If the stock rises above the strike, your call gains value. Your maximum loss is limited to the premium you paid
- Sell (write) a put option: you collect the premium and hope the stock stays above the strike price so the put expires worthless. Your maximum gain is limited to the premium received
Exam Tip: Gotchas
Selling a put is bullish, not bearish. The writer wants the stock to stay above the strike so the put expires worthless.
Bearish Strategies
If you expect prices to fall:
- Short sell stock: borrow and sell the stock, then buy it back at a lower price. Maximum loss is unlimited because the stock can rise indefinitely
- Buy a put option: gives you the right to sell at the strike price. If the stock drops below the strike, your put gains value. Your maximum loss is limited to the premium paid
- Sell (write) a call option: you collect the premium and hope the stock stays below the strike price so the call expires worthless. If naked, your maximum loss is unlimited
Exam Tip: Gotchas
Selling a call is bearish/neutral, not bullish. The writer wants the stock to stay at or below the strike so the call expires worthless. A naked call carries unlimited loss.
Matching Strategy to Risk Tolerance
| Risk Level | Bullish Strategy | Bearish Strategy |
|---|---|---|
| Conservative (limited loss) | Buy call (max loss = premium) | Buy put (max loss = premium) |
| Moderate | Buy stock (max loss = purchase price) | Sell call, covered (max loss = stock decline minus premium) |
| Aggressive (unlimited loss possible) | Sell put (substantial loss if stock drops) | Short sell stock (unlimited loss) or sell naked call (unlimited loss) |
Exam Tip: Gotchas
Option buyers always have limited risk (they can only lose the premium paid). Option sellers (writers) take on greater risk; potentially unlimited risk for naked call writers. The exam will test whether you can identify the maximum gain and maximum loss for each strategy.