Options Trading in Bear Market: Retired Math Teacher

Options Trading in Bear Market: Retired Math Teacher

• Steve Chen focuses on the delta and theta decay when setting up bear calls spreads.
• He sticks to delta rates between 0.16 to 0.20 to collect premium and mitigate risk.
• He also keeps his contracts between four to six weeks for ideal theta decay.

Steve Chen was a middle-school math teacher before he became an options-trading wizard. His math and teaching skills now come in handy both when he’s determining optimal settings for his options contracts, and coaching others on how to do the same.

Today, he’s the founder of Call To Leap, a website that teaches financial education around saving and investing, including options trading, for a fee. He also shares daily finance tips and simplifies basic stock market terminology in short videos through his TikTok and Instagram.

This outcome wasn’t planned. When Chen started his teaching career, he didn’t anticipate ditching his job by the age of 33. But after realizing his $5,000 monthly paycheck and all the deductions it incurred wouldn’t be enough to live comfortably in a state like California, he began looking for additional income streams.

He dabbled in tutoring after hours, slashed his spending, created YouTube and TikTok videos for extra ad revenue, and invested a bit of his money in stocks and exchange-traded funds (ETFs). As he became more comfortable investing in the stock market, he began to learn about different strategies online.

A common theme he noticed from reading many blog posts was that traders who bought short-term options had been losing money. So Chen thought he would do the opposite and sell options instead.

He enjoyed a rip-roaring ride while the market was bullish in 2020 and 2021 because he was holding stocks that were rising in value while selling contracts on them that often weren’t executed. This meant he was able to keep his shares while collecting premiums on the contracts.

Records viewed by Insider show that Chen had a net profit of $76,925.88 for 2021 from options trading. He trades both in a regular brokerage account and in a tax-advantaged retirement account. He estimates that about 5% came from dividends paid by the underlying stocks he had call options on, 10% from capital gains from selling the call options, and the remainder came from premiums. In 2020, previous records viewed by Insider showed he had an even higher profit at $114,000 for the year.

However, since the stock market turned bearish late last year, he has been focused on a specific type of options strategy known as bear call spreads. This approach allows him to benefit from the falling price of a stock, as well as the decayed value of the contract he’s selling.

It’s a two-step process whereby he purchases a cheaper options contract with the same shares he plans to sell in another contract to act as a proxy. This allows him to continue options trading without needing to hold stocks that could be falling in value.

His contract’s sweet spot for optimal returns and risk mitigation

When Chen sets up an options contract, there are two key variables he focuses on to help him mitigate risk: the delta ratio and the theta decay.

The main variable that’s key to determining risk is the delta ratio, which is a theoretical estimate of how much the value of an options contract will change based on the change in price of the underlying shares. It also helps roughly determine the probability the market price will hit the strike price or be in-the-money. The higher the delta, the higher the risk. The delta rate can be found listed on the options chain.

When Chen is selling a call option contract, he will stick to a delta rate close to 0.16 because it’s the sweet spot of getting enough premium while not risking too much that the price of the stock will hit that strike price by expiration. Depending on what’s available, he will go as high or close to a delta 0.20.

The image above is an options chain for Advanced Micro Devices, Inc. (AMD). Based on the available contracts, Chen told Insider he’s most likely to pick the option that has a delta 0.21 with a strike of $100.

He also needs to consider theta decay, which is the rate of decline in the value of the contract over time. He typically chooses contracts that expire within 30-45 days. This is because short-term options have a higher theta decay. If the contract’s value drops substantially, he could purchase it back and close it out, removing his risk exposure for the remainder of the days it could have been active. This is ideal during a downward trending market.

“The goal of an options seller is to sell an option contract to someone, let it decay over time, and potentially purchase that option back for a lower price,” Chen said. “Theta decay is fastest from a mathematical sense when the option contract is less than four to six weeks out.”

On the other end, if the contract is too short, the options premium will be too low.

Example from one of his trades

On March 7, Chen set up a bear call spread by first purchasing three AMD contracts with an expiration date of Apr 1, 2022 at a strike price of $165. AMD was trading near $108 per share at the time. Since the strike price was far out of the money, he only paid $16.98 for the trade. He recalls the contract having a delta of 0.03. Then, he sold three AMD contracts with the same expiration date at a strike price of $125 for $337.01. He recalls it having a delta of 0.16. The contract with lower strike price has a relatively higher risk compared to the contract with the higher strike price because the probability of the stock price hitting the strike is higher.

At the time, AMD’s stock was trading at around $108. Therefore, even though the contract he sold had a higher probability than the one he purchased, there was a relatively low probability that the price of the stock would hit the $125 strike price by expiration.

In this instance, both options contracts expired worthless. This trade earned him a net profit of $320.03.

Chen’s risk escalates if the market price nears the strike price because it increases the possibility that the person on the other side of the trade decides to purchase the shares. If so, Chen would need to possess those shares to honor the transaction. To cover himself, he will set a buy stop market order at a price slightly below the strike price.

There are two risks here. The first is if the order isn’t executed in time and the shares are purchased at a price higher than the strike price. The second is if the buy stop order is triggered and then the price of the stock drops back down. This scenario could leave him holding shares that aren’t sold.

While this hasn’t happened to him recently. In 2020, one of his buy stop orders was triggered on AMD shares. However, the contract was not executed and he was left holding those shares with an unrealized loss. To recover his losses, he continued to sell covered calls on the shares until he was back in a net positive.