When a company fails, some people might think that it's time to panic. However, for investors who know how to bet against a stock, this can be an opportunity to make some serious profits.
In this article, we will discuss 3 different ways of betting against stock and the risks associated with each one. So whether you're looking to short a stock or simply want to understand what it means to bet against one this is for you.
What does it mean to bet against a stock?
When someone says they are betting against a stock, it means they are going to profit in the event of the stock price going down. This is the opposite of how most people invest, which is called taking a long position.
When you take a long position, you are hoping the stock price will go up so you can sell it at a higher price and make a profit. Betting against the stock can be seen as a counterproductive way to play the capital markets and many people are against it.
However, it can be a profitable strategy if done correctly. We won't get into the different philosophies behind the ethics of betting against a stock in this article.
By understanding, that betting against a stock is a meaningful way for you to grow your portfolio, you can make an informed decision about whether or not to employ this strategy.
How do you short a stock?
To short a stock, you would first need to find a broker that offers this service. Not all brokers do, so it's important to check before you open an account. You will also need a margin account with your broker. Once you have found a broker, you can then place a short sell order.
This is an order to sell a security that you do not own. When the order is executed, you will borrow the security and sell it. You can profit from this by buying the security back at a lower price and return it to the broker, pocketing the difference. In this scenario, the one betting against the stock is called "short selling."
How do you bet on stock to fail?
Short selling is the most common way to bet on a stock to fail. You can simply borrow shares of the stock, sell them, and hope to buy them back at a lower price. This can be a more difficult concept to wrap your head around than simply betting in favor of the stock, but if it looks like a company is going to fail, taking a short position could be a great way to profit.
3 ways of betting against a stock
In addition to short selling, there are 2 additional ways to bet against a stock. In this section of the article, we will review the other two options and review short selling. By going over all three options, you can make the best decision about which option would work best for you.
1. Selling a call
This is when you sell someone the option to buy a stock at a certain price. If the stock falls below that price, you make money. For example, let’s say you sell a call for XYZ stock at $100. If the stock price remains around $90 at the expiration of the option, you make a profit.
The cash premium received and not having to buy the stock at $100 is your profit.
2. Buying a put
Having the right but not the obligation to sell a security at a set price, puts gives the buyer downside protection in case the price of the underlying falls. Puts are most commonly used as a hedge but can also be deployed as a way to bet against a stock.
If you think a certain stock is going to go down in price you can buy a put on it, and if the stock falls below the strike price you can make a profit
As a review, shorting is when you sell a security you do not own and hope to repurchase the same security at a lower price so you can have a profit. Shorting is less complicated than options but can still be an effective way to bet against a company.
What are the risks of betting against a stock?
If you are betting against a stock through short selling and the price of the security goes up instead of down, you will have to buy it back at a higher price and take a loss.
The same is true if you sell a call because the holder of the call will have the right to buy the security at the agreed strike price. Buying a put offers less risk because you can only lose the cost of the put.
You should also only bet against a stock if you are comfortable with the risks and have done your research. Your bear thesis might be wrong if the company’s fundamentals have changed or there is new information that you are not aware of.
Lastly, keep in mind that when you bet against a stock, you are essentially betting that the company will fail. This might not sit well with some market participants and they might make a point to buy the stock and raise the price just to spite you.
Betting against a stock is an option that many investors ignore. Traditional value investors that look for undervalued stocks might not ever consider betting against a stock. Many growth investors also don't align with the idea and concept of betting against a company because as the name suggests, they prefer to see growth.
However, if you are comfortable with the risks and have done your research, betting against a stock can be a profitable way to invest. Just be aware of the risks involved and make sure you are comfortable with them before taking a position.
The three options for betting against a stock are more complicated than a simple buy-and-hold strategy, but if you are confident in a company's downfall, it might be the right move for you.
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