When you want to short a stock with options you have two basic choices: options or shorting. But how to short a stock with options? Well, you can either buy a put option or sell a call option.
We will discuss the differences between these two strategies and help you decide which is the best for you.
Can you go short with options?
Yes, you can get short exposure to a stock using options, either by buying a put or selling a call. This will position you to profit from a decline in the stock price.
With shorts, you're betting that the stock will go down in price. If you add options to this strategy, you're also betting that the options will increase in value.
How do you short with an option?
If you are wondering how to short a stock with an option, the process is actually quite simple. You can do it by buying a put option or selling a call option.
Buying a put
If you think a stock is going to go down, you can buy a put option. This gives you the right to sell the stock at a certain price. If the stock goes down, the option will increase in value.
Selling a call
You can also sell a call option. This gives someone else the right to buy the stock from you at a certain price. If the stock goes down, the option will decrease in value.
Both of these strategies are ways to get short exposure to a stock. And both of them involve options. So, if you're looking to short a stock with options, you have two different ways to do it.
How shorting with put options works
If you're looking to short a stock with options, one way to do so is by buying put options. Put options are contracts that give you the right, but not the obligation, to sell a stock at a certain price within a certain time frame.
When you buy a put option, you're essentially betting that the stock will go down in price. If it does, you can then sell the shares at the strike price and pocket the difference, or you can sell your put option contract.
However, if the stock goes up instead of down, you'll be stuck with a worthless option contract. So before shorting with put options, make sure you do your homework and are comfortable with the risks involved.
Shorting by buying a put option example
For example, let's say you wanted to short XYZ stock, which is currently trading at $50 per share. You could buy a put option for 100 shares with a strike price of $45 that expires in two months.
If the stock falls to $40 within that time frame, you can then exercise your option and sell the shares for $45 each, netting a $500 profit minus the premium you paid for the option.
On the other hand, if the stock goes up to $55, your option will expire worthless and you'll be out the premium you paid for it.
As you can see, there's a lot of potential for profit when shorting with put options, but also a fair amount of risk. So make sure you know what you're doing before taking the plunge.
How shorting with selling call works
When you short a stock, you're essentially borrowing shares of the stock from somebody else, selling the stock, and then hoping to buy the stock back at a lower price. This is so you can return the shares to the person you borrowed them from and pocket the difference.
One way to do this is by selling call options. A call option gives the holder of the option the right but not the obligation to buy shares of a particular stock at a set price (the strike price) on or before a certain date (the expiration date).
When you sell someone a call option, you're giving them the right to buy the stock in exchange for money (the premium). If the share price stays below the strike price before expiration, you keep all of the premium.
If it doesn't, you have to sell the stock at the strike price and may end up losing money. Especially if you do not own the shares yourself, and you have to buy them on the open market.
Selling call options can either be covered or uncovered. When you sell a covered call that means that you own the shares, in case the option buyer decides to exercise it before expiration.
However, uncovered option selling means you do not own the shares, and therefore you will have to buy those shares on the open market to give them to the call owner if the options gets exercised.
Shorting by selling call options example
Here's a more detailed example: Suppose XYZ stock is trading at $50 per share. You believe it will fall to $40 so you decide to short it by selling a call option. The option has a strike price of $55 and expires in two months.
You receive a premium of $100 for selling the call. When you sell the call, you're obligated to sell 100 shares of XYZ stock to the person who bought the option if they choose to exercise their right to buy it at $55 per share on or before expiration.
If XYZ stock falls below $55, they won't exercise their option and you keep the $100 premium. If XYZ stock is above $55 at expiration, you have to buy it at $55 and then sell it to the option holder at that price, meaning you will have lost money on the trade.
In this case, your loss is limited to the difference between the strike price and the stock's current price minus the premium you received.
Shorting vs options
Shorting with options can be a more complex way of shorting a stock than simply borrowing shares and selling them, but it does give you some flexibility in terms of how much money you can lose if things don't go your way.
The flexibility you receive is because when you short a stock using options, you're not buying or selling the underlying shares. This means you don't have to put up any money to buy the shares, which can be beneficial if you don't have much capital, to begin with.
It also means that your potential losses are limited to the premium you paid for the option (put), plus any commissions and fees. However, selling call options carries a lot more risk, because you will be forced to sell the shares.
Of course, if the stock goes up instead of down, you'll still have to buy it at a higher price and may end up losing money. But if you're confident in your research and believe the stock is going to fall, shorting with options can be a great way to profit from it. Just remember, there's always some risk involved so make sure you know what you're doing before getting started.
Differences between buying a put and selling a call
The main differences between buying a put and selling a call are the following:
- When you buy a put, you have the right to sell shares at a set price
- With buying a put you can only lose the premium paid for the option
- When you sell a call, you agree to sell shares at a set price
- Buying a put is used as protection against potential stock losses while selling a call can be used to generate income from stocks that are not expected to rise in value
- Selling a call carries a lot more risk because your losses can be unlimited
Risks of buying a put and selling a call
When you short a stock with options, you are essentially buying a put or selling a call. This can be a risky proposition if the stock price goes up, as you will be responsible for paying the difference between the strike prices of the two options.
The major difference between buying a put and selling a call is that when you buy a put all you can lose is the premium you paid for the option. However, if you sell a call and the stock goes up a lot, you have to deliver those shares if the call option buyer exercises. This can be extremely risky if you are selling uncovered options, which means you do not own those shares, and you will have to buy them on the open market at whatever price the stock is trading.
Therefore, it is important to carefully consider all of your options before shorting a stock with options.
While there are risks associated with shorting a stock with options, there are also potential rewards. If done correctly, you can generate income from both the premiums received from selling the call.
Before shorting a stock with options, be sure to consult with a financial professional to get an idea of the risks and rewards associated with this strategy.