Short selling and put options aren’t new to people who invest. Short selling and put options are generally considered bearish strategies by speculators when used on stocks or indices that are likely to decline. Both strategies are effective in mitigating downside risk.
Despite the similarity of short selling and buying put options, the two strategies differ in crucial aspects, including suitability, risk, and return.
A put option is an insurance contract: you pay a premium to be able to sell at the strike price but not have to. The stock must be below the strike price at expiration to make your option in the money (profitable for you).
Whereas, short-sell is a bearish strategy that involves selling a stock that the seller doesn’t own but borrows and then sells in the market. When a trader believes that a stock, currency, commodity, or other assets will take a significant downward move in the future, they short sell it.
Let’s talk more about these two terms.
What Is Meant By A Put Option?
The put option lets you sell an underlying security at a predetermined price over a specific period.
A put option offers an alternative to buying a bearish position in a stock or index. Put options give you the right to sell an underlying asset at a specific price.
The trader doesn’t have to buy the stock, commodity, or other assets that the put secures. The parties to the contract negotiate the terms of the agreement.
When you purchase a contract, you pay the seller a predetermined fee per share (the “premium“). Approximately 100 shares of the underlying stock are included in each contract. If you do not own the underlying stock, it makes no difference.
What Is Meant By A Short Sell?
The act of short selling consists of borrowing securities and then selling them. You then purchase it at a lower price, pocketing the difference after repaying the loan.
Traders may use short selling to speculate. Taking long positions in the same stock or a related one can reduce the downside risks of hedge investors or portfolio managers. Speculation in the stock market is a hazardous activity. You reduce your risk exposure by taking an offsetting position with a hedge transaction.
Shorting is an investment strategy that experienced traders and investors should only employ. Shorting is the act of betting that the price of a stock or other security will decline in the future.
Differences Between A Put Option And A Short Sell
The significant difference between a put option and a short sell is that a put option allows you to sell a security at a predetermined price before a particular date.
At the same time, a short sale will enable you to borrow stocks and sell them immediately. Moreover, you can purchase those stocks later and return them to the owner.
Both of these allow you to get a profit in situations when the stock markets are dwindling.
The table shows the differences between a put option and a short sell.
|Put Option||Short Sell|
|You buy stock in the put option.||In short sell, you can borrow a stock.|
|There is no obligation for you to sell it immediately.||You have to sell it to the market immediately.|
|It’s a pretty safe option in trading and has limited risk.||The risk of loss is infinite in selling short.|
|You have a backup premium to compensate for your loss.||You don’t know if your shares are going up or down.|
|You only lose the amount you paid for buying your put.||Your loss depends on the price hike of the stocks in the market that is unlimited.|
|A put option has an expiration date as its value decreases with each passing day.||You don’t have a problem with expiration or a decrease in the value of your stock in a short sell.|
Here is a short video overview of the significant differences between put option and short sell.
Should I Sell A Put Instead Of Buying A Call?
It would be best if you prefer selling a put instead of buying a call since selling a put gives you an immediate profit. However, buying a call results in an immediate loss.
If you sell your put option in a market, you can gain a profit out of it. Selling a put option is favorable for you if you are sure the market stock will go down in price. However, if the market goes up, the put option cannot give you a significant profit.
Unlike the put option, buying a call can allow you to cash out more profit in the future.
So, it all depends on the market situation and whether you should sell a put or buy a call.
Why Would You Sell A Put Option?
With put options, investors have the opportunity to sell the underlying security at a future date and at a more favorable price.
It’s easier to get into commodities futures trading with put options because they’re at lower risk. When you purchase a put option on a commodity, you can sell the futures contract underlying it.
Put Option: How Do You Make Money With It?
You can make money with a put option by acquiring a short sell position in a market.
Those who purchase put options make money by holding a short position. If you’re an owner of a put option, you can make money when the stock falls below the strike price before the expiration.
Moreover, before the expiration date, the put buyer is entitled to keep the strike price if he exercises the options.
What happens when my put hits strike price?
The price at which an underlying asset is sold when you purchase a put option is known as the strike price.
For instance, if you purchase a put option with a $10 strike price, you can sell that specific stock for $10, even if its price was less than $10. Moreover, you can gain profit by selling the put option.
Is short selling illegal?
Short selling is considered a legal stock trading process in which the stock prices drop when traders bet.
Some critics believe that short selling is a bet in opposition to growth therefore it is an unethical act. However, most economists recognize the importance of efficient and liquid markets making short selling an important part of the economy.
Can You Sell A Put Option Early?
You can sell a put option before its expiration date as it’ll give you significant profit.
If you own a put and you want to sell the stock before expiration, it’s mostly a great idea to sell the put first and then immediately sell the stock. That way, you’ll capture the time value for the put and the stock’s value.
What Happens If You Don’t Sell Your Put Option In Time?
It loses its worth if you don’t sell your put option in time.
When the time extended on the put expires, it loses its value. The put option has no value and is worthless if the underlying security’s price is more elevated than the strike price. When this happens, the put option is considered out of the money.
How Do You Short Sell a Stock?
You have to follow four steps to short sell a stock.
- Take out a loan against the stock you want to bet on.
- After borrowing shares, you sell them right away.
- As soon as the stock falls, you repurchase it at a lower price.
- When you’re done with the shares, you return them to the brokerage and pocket the difference.
How Long Can You Short A Stock?
There is no defined limit of time to keep a short position. It mainly depends on the broker lending you the stock for short selling.
A short position can be held for as long as you want. When you short sell, you have a broker willing to lend you stock with the understanding that it’ll be sold on the open market and replaced in the future. So it all depends on your broker.
Here are a few takeaways about the differences between a put option and a short sell.
- In put options, you can sell a stock at a predetermined price before a specific date; in short sales, you can borrow stocks and sell them immediately.
- Put options do not require you to sell them immediately. Short sales need you to sell your stock immediately to the market.
- Furthermore, a put option is a pretty safe trading option compared to a short sell.
- Apart from this, you are bound to sell your put at a specific time. Otherwise, it becomes useless. However, there is no particular period for you to hold a short-selling position.