Mastering Derivatives: Fading Prices With Options

If you want to fade prices, should you choose the stock, its futures contract or trade options? This week, we look at why options are optimal for fading prices.

Limited loss

Fading prices is risky. It involves shorting when the stock has run-up too much or going long when the stock has declined too much. It is important to be find enough evidence that bulls are exhausted before you decide to go short. Likewise, you must be convinced that bears are exhausted before you decide to go long. You can read multiple signals from the chart. If you use candlestick charts, you can look for single or two candle reversals. You can also check if volumes have sharply increased late into the uptrend or downtrend before the first sign of price reversal. A continual shrinking body of the candle is also sign of exhaustion.

But why are options optimal for fading prices? Shorting a stock for a potential bearish reversal (bull exhaustion) may not be practical. This is because brokers do not allow retail traders to go short beyond a day. Even if they do, the cost of borrowing the stock for delivery can be expensive. This is, of course, not an issue with futures. You can go naked short on futures: carry your short position until just before expiry without being obligated to deliver the underlying. But futures move nearly one-to-one with the underlying. So, a false bearish reversal sign may lead to significant losses if the stock pauses and immediately moves up. In contrast, the maximum loss on your long option position is the premium paid. Importantly, the price of a put may be relatively low compared to call because the recent uptrend in prices may have pushed demand for calls over puts. Lower demand for an option leads to lower implied volatility.

What about a potential bullish reversal? You can buy a stock or a futures contract on it. But if it turns out to be a false signal, your position will suffer significant losses. Buying a call may be optimal. Also, call prices may be relatively low compared to puts that are located at a similar distance from the current underlying price. You could also set up a bull call spread, or a bear put spread if you can identify a strong support level for a bearish reversal and a strong resistance level for a bullish reversal.

Optional Reading

Professional traders prefer to short options to fade prices. That is, they prefer to go short on calls for potential bearish reversal and short on puts for a potential bullish reversal. Their objective is to capture gains through time decay from higher implied volatility. Managing the position requires discipline. This is because fading prices is risky as is shorting options. The strategy will require large trading capital, as short options attract margin requirements. So, it is optimal for retail traders to go long on options than short them.

(The author offers training programmes for individuals to manage their personal investments)

Published on January 17, 2026