If you’re new to investing, you must have heard about short selling and put options. The lines of difference between short selling and put options are often blurred. But they’re not actually the same strategy.
Short call Vs short put: Meaning
Both short selling and put options are basically bearish strategies and are used by speculators on expected declines in underlying securities or indexes. These strategies can also assist in hedging downside risks in your portfolio. They have common features but it’s important to understand the short stock Vs put option differences.
To understand the short selling Vs put options differences, let’s have a detailed look at what each one entails.
Short sell Vs put: Comparison
Short selling involves selling of a security that you don’t actually own but have borrowed in the market. It’s something traders do when they predict that a stock, currency, or any other asset will have a significant downward movement in the future. It is also called shorting or going short. To put the difference between short selling and put options in perspective, here’s what put options mean.
Put options are an alternate way of taking a bearish position on securities and indexes. When you buy a put option, you buy the right to sell underlying assets at prices stated in options. You have no obligation to purchase the asset secured by the put. Since the two are quite similar by primary definition, it is difficult for beginners to grasp the difference in short call Vs short put in the beginning.
Short selling Vs put options: Risk
The long-term market trend is always upwards, and hence short selling is considered quite dangerous. It is riskier than put options. Since stock values can rise indefinitely, risk is technically unlimited.
On the contrary, put options, too, come with risks that aren’t as huge as those with short selling. The biggest loss you can incur is the premium you pay for buying the option, and the expected profit could be high. Hence, the risk factor is clearly tilted towards short selling in short stock vs put option.
Short sell Vs put: Costs
Costs usually boil down to margin requirements when it comes to assets on the market. That’s exactly what makes short selling more expensive. The margin also increases when the shorter asset’s price increases.
On the other hand, there is no requirement of a margin account when it comes to put options. You can initiate a put easily with a limited capital as well. However, since you won’t have the luxury of time, you might actually lose all your money spent buying puts in case the trade doesn’t take off.
Another twist to the tale is implied volatility. If you buy puts on very volatile stocks, you might end up paying very high amounts. The cost in such cases must be justified by the risk to the portfolio holding or the long position.
Thus, the costs of short stock Vs out option are variable.
Short call vs short put: Purpose
Short calls are meant for either speculation or to indirectly hedge exposure. By shorting, you could hedge exposure and create a short position. If the stock falls, you could repurchase it at a lower rate and keep the difference.
Meanwhile, put options could directly hedge risk. Puts are considered suitable for hedging the risks of decline in a portfolio. Even if the expected decline in underlying assets doesn’t happen, the rise might just offset a part of the premium you had paid.
Thus, the purpose of short sell vs put is actually different, even though it might seem similar at first glance.
Now that you know the points of difference for short stock vs put option, you can make a more informed decision before going for either.
Short selling vs put options: Which one to pick?
There is no objective choice in this regard. But it is highly recommended that only investors with a considerable amount of experience opt for either. The decision of whether to choose a short sell or a put option depends on factors such as:
– Investment expertise
– Risk capacity
– Availability of funds
– Purpose of trade: speculation or hedging
Ultimately, you must remember that investment knowledge and experience is the most important factor. No strategy can give you predefined results, it’s all a game of wisdom.