My view last week was that the markets could reach their most recent highs (that would be approximately 12,000 on the TSX Composite Index or 10,400 on the Dow Jones Industrial Average). The TSX has yet to reach its mark. But the DJIA did and then pulled back… abruptly!

Earnings were expected to be positive. And many felt that would be enough to entice buyers back into the game. At least for the short term. But so far, earnings have been a mixed picture, and macro events continue to drag investor enthusiasm.

What’s clear is that global economies are not recovering as fast as expected. For that to change, consumer spending will have to step up big time. Especially as governments gradually withdraw stimulus programs.

The problem is that no one sees that happening. Which is why, after just a week of second quarter earnings, analysts are already lowering expectations.

Traders need to be cautious, and if anything, might want to reassert their bearish bias over the near term. Potential option strategies include 1) buying puts or 2) writing bear call spreads.

Buying puts is the first choice if premiums remain relatively low. Before deciding which strategy to use, check the levels on the MX Implied Volatility Index (symbol MVX). The MVX closed on Friday at 16.53. I would consider any level below 20 as a low number in the current market environment.

The S&P/TSX 60 Index Fund (TSX: XIU) closed Friday at $17.03. If you buy the bearish scenario, look at buying the XIU August 17 puts at 43 cents or better. The XIU options are liquid so you should have no difficulty moving in or out of any position.

Bear call spreads make more sense if option premiums make the cost of an outright purchase prohibitive. As mentioned, that would be any value above 20 on the MVX.

A bear call spread, like any spread, typically reduces the impact of volatility. A spread involves the simultaneous purchase and sale of options on the same underlying security. If you overpay for the long option, you are benefiting from the excess premium received on the sale of the short option. Effectively one option premium cancels the other.

Typically, you would sell an at-the-money or in-the-money call and simultaneously purchase of an out-of-the-money call. For example, with XIU, you could write the in-the-money August 16.50 calls at 75 cents and simultaneously purchase the out-of-the-money August 17.50 calls at 20 cents. This bear call spread generates a credit of 55 cents.

This spreads maximum profits occurs if, at the August expiration, XIU is below $16.50. At that point both of the XIU August calls expire worthless and you retain the net credit received.

The risk in this position is limited by the purchase of the August 17.50 call. If XIU were to rally above $17.50 between now and the August expiration, any additional losses on the short August $16.50 call would be offset by gains on the long August $17.50 call.

The maximum risk with the bear call spread is the difference in strike prices less the net credit received (Aug 17.50 call minus August 16.50 call = $1.00 risk less $0.55 net credit received = $0.45 net risk).