If you’re bearish on a stock, you can try to capitalize on your position in a few ways:
- Sell the stock, if you own it.
- Sell the stock, even if you don’t own it, by borrowing shares via your brokerage firm. At a later date, you can buy the shares (hopefully at a lower price) to pay back your broker. That’s called short selling.
- Or you can buy a put option, which gives you the right to sell stock at a given price for a pre-determined timeframe.
Why buy a put instead of selling short?
Short selling can be tough. Short sellers must contend with margin requirements and special rules about when they can or can’t place a sale. Margin is essentially a line of credit for trading stock, for which you make a minimum down payment and pay your broker an interest rate. If the market moves against you suddenly, you may be required to quickly add to this down payment in a margin call. Study the risks of margin to use this tool wisely.
If you’re wrong about your bearish outlook and the stock price starts to rise, your risks climb considerably, too. You must deliver those shares of stock to the brokerage firm. Since there’s no limit on how high a stock price can climb, buying them when they’re on the rise means there’s theoretically no limit on your risk. Plus, you’ll continue paying interest on the margin balance until the position is closed.
Buying a put can potentially offer a relatively low-cost, hassle-free alternative to short selling for bearish investors.