How to short stock with options
Sometimes investors become convinced that a stock is more likely to fall in value than to rise. If that's the case, investors can potentially make money when the value of a stock goes down by using a strategy called short selling. Also known as shorting a stock, short selling is designed to give you a profit if the share price of the stock you choose to short goes down -- but can also lose money for you if the stock price goes up. Typically, you might decide to short a stock because you feel it is overvalued or will decline for some reason.
Since shorting involves borrowing shares of stock you don't own and selling them, a decline in the share price will let you buy back the shares with less money than you originally received when you sold them.
Short Combination
However, there are some other situations in which shorting a stock can be useful. If you own a stock in a particular industry but want to hedge against an industrywide risk, then shorting a competing stock in the same industry could help protect against losses.
Shorting a stock can also be better from a tax perspective than selling your own holdings, especially if you anticipate a short-term downward move for the share price that will likely reverse itself. You think that stock is overvalued, and you believe that its price is likely to fall in the near future. Accordingly, you decide that you want to sell shares of the stock short. You follow the process described in the previous section and initiate a short position.
That money will be credited to your account in the same manner as any other stock sale, but you'll also have a debt obligation to repay the borrowed shares at some time in the future. That represents your profit -- again, minus any transaction costs that your broker charged you in conjunction with the sale and purchase of the shares.
Keep in mind that the example in the previous section is what happens if the stock does what you think it will -- declines. The biggest risk involved with short selling is that if the stock price rises dramatically, you might have difficulty covering the losses involved. Theoretically, shorting can produce unlimited losses -- after all, there's not an upper limit to how high a stock's price can climb.
Your broker won't require you to have an unlimited supply of cash to offset potential losses, but if you lose too much money, your broker can invoke a margin call -- forcing you to close your short position by buying back the shares at what could prove to be the worst possible time. In addition, short sellers sometimes have to deal with another situation that forces them to close their positions unexpectedly.
If a stock is a popular target of short sellers, it can be hard to locate shares to borrow. If the shareholder who lends the stock to the short seller wants those shares back, you'll have to cover the short -- your broker will force you to repurchase the shares before you want to.
The Short Option: A Primer on Selling Put and Call Op - Ticker Tape
Short selling can be a lucrative way to profit if a stock drops in value, but it comes with big risk and should be attempted only by experienced investors. And even then, it should be used sparingly and only after a careful assessment of the risks involved. A trader who has a short position in a stock will be severely affected by a large price increase because the losses grow as the price of the underlying asset increases. The danger to the trader comes from not determining and sticking to an exit strategy when the trade starts to go south and holding the position far longer than they should so as to mitigate the loss.
In contrast, the purchase of a put option allows an investor to benefit from a decrease in the price of the underlying asset while also limiting the amount of loss they may sustain. The purchaser of a put option will pay a premium to have the right, but not the obligation, to sell a specific number of shares at an agreed-upon strike price. If the price rises dramatically, the purchaser of the put option can choose to do nothing and just lose the premium. This limited amount of loss is the factor that can be very appealing to novice traders.
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Your Money. Personal Finance. Your Practice. Popular Courses. Short Selling vs. Put Options: An Overview Purchasing a put option and entering into a short sale transaction are the two most common ways for traders to profit when the price of an underlying asset decreases, but the payoffs are quite different.
The Ultimate Guide To Shorting A Stock With Options
Key Takeaways Traders can profit when the price of an underlying asset drops by purchasing a put option or entering into a short sale transaction. With a short sale, an investor borrows shares from a broker and sells them on the market, hoping the price has decreased so they can buy them back at a lower cost. If the price has risen, they lose money. Buying a put option allows an investor to benefit from a drop in the price of the underlying asset, while also limiting how much loss they may sustain if the price rises.
The buyer of a put option can pay a premium to have the right, but not the requirement, to sell a specific number of shares at an agreed-upon strike price.
Why would you short a stock?
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