What is a Bullet Trade?

A bullet trade is a short sale technique used when a market is bearish, moving in a downward direction. In a bullet trade, investors take a short position by buying a put option said to be "in-the-money" because the option's strike price is higher than the worth of the underlying asset. This allows the trader to essentially short sell the stock without doing so directly. When rules limit short sale activities, bullet trades allow people to execute trades when they wouldn't otherwise be able to.

Historically, people were only allowed to make short sales after an uptick, meaning that as long as the market was declining, they could not sell their stocks. This put investors in a potentially problematic position and also created situations where people could not execute trades to take a short position in a bear market. Options allowed people to take short positions without actively making a trade, providing a mechanism for profiting in a bear market.

Using a bullet trade allows people to profit from a drop in stock value. The more the stock declines in value, the greater the potential profit for the person who holds an in-the-money option on that stock. The option itself has value and can be sold to another investor interested in using it for profit. Using stock options for speculative trading can potentially backfire on an investor, as options purchases require making predictions about the future movement of the market and even in a bear market, stocks do not always behave as expected.

Trades of this nature are typically used by experienced investors, acting on behalf of themselves, their firms, or clients. When an appealing bullet trade becomes available, the trader must critically evaluate it to decide if it is a good buy and must be able to act very quickly to make an investment decision. Traders who attempt to work the bear market for profit must exercise a number of skills to trade successfully and can take losses very quickly if they are inattentive or make poor trading decisions.

The availability of a bullet trade depends on a number of different factors. Such trades may be available when it is difficult to take a short position by making direct stock trades, but sometimes they are more limited. Experienced traders may snap up the best available options, limiting choices for people who don't have existing relationships with traders or are unfamiliar with the investment environment.