In our previous article, How to implement an asymmetric payoff strategy: Part 1- stop loss, the wrong way, we talked about using a wrong way to implement an asymmetric payoff strategy. Today, we will talk about the proper way to do so.

 Our preferred method of profiting from a possible stock market crash (see How to take advantage of an impending crash- Part 4: asymmetric payoff) is to use derivatives called options. Contrary to common misperception, options are inherently not ?risky? and ?dangerous.? When used properly, options can in fact reduce your risks significantly. It is the misuse of options that can result in severe loss, which probably give it such a bad reputation in the first place (see our articles on options here).

Also, options are arguably the most complex topic in finance, which could explain why they have the feel of mystic and danger to those who are uninitiated. Understanding options involves knowing options pricing theory, which uses complex mathematical formulas and algorithms that involves the Bell curve (see How the folks in the finance/economics industry became turkeys?Part 2: The Bell curve, that great intellectual fraud). Thus, we cannot go too much into any detail about options for today’s article. We can, however, point you to the right direction.

The great thing about using options is that with specific combinations of short (sell) and long (buy) puts and calls, you can profit from all kinds of market conditions (bullish, bearish or neutral, volatile, stable, trending, trendless, etc). For example, there are options strategies for taking advantage of extremely stable (and boring) markets. There are also strategies for taking advantage of highly volatile markets when you have no conviction on the direction of the market.

For the very specific purpose of profiting from a possible stock market crash, a suitable options strategy would be the Put Backspread. The profit/loss pay-off diagram for this strategy is this:

As you can see, with such a strategy, you maximum loss is if the stock price remains stagnant at $90 by the time the options expire. If you are wrong about the direction of the stock price (i.e. stock price shoot up suddenly), you still can make a profit. But if you are right about the stock price crash, your profit can be unlimited.

There are much more about options that what we mention here. If you want to learn more about options, there are some books that we recommend here.