Short Selling Vs. Puts

Well, this is precisely what short sellers and traders using put options are doing in bearish markets. However, short selling and put options are very different in many ways - capital needed, risks involved, amount of potential profit, time limit, and trading strategy specifics.

For traders in a bearish market who want to improve their trading knowledge and have better trading planning skills, it’s very important to understand the difference between short selling and puts, especially for traders using short-selling specific platforms like TradeZero.

Short-selling is a bearish trading strategy that involves borrowing a stock from the broker, instantly selling it, and then waiting for a price drop to buy it back. This strategy revolves around the anticipation of a bearish trend in the market and by “buying it back” later, for a lower price. The price difference is what the short seller earns as profit when the borrowed stock is returned to the broker.

For instance, if a trader short-sells 20 shares of a company at $100 each and buys them back at $80, the $400 difference is the profit.

Owning a margin account is necessary for any trader to become a short seller. With a margin account, a trader can locate borrowable stocks. For instance, at TradeZero, a short seller can locate them in three ways. Traders who want to sort and cover the same stock multiple times during the day can use the standard Locates . If a short seller is looking to trade threshold securities one time, then using Single Use Locates may be the best option, and if it is unused, traders may have a portion of their fees refunded if utilized by another trader. Traders who are looking to secure shares in advance and reduce the risk of buy-ins can use Pre-Borrows.

Short sellers can hold their positions indefinitely. However, certain situations like margin calls, short squeezes, media hype, fees (including overnight borrow fees, etc) and more might deter traders from holding on for too long . The biggest risk involved is the short squeeze. This is when excessive optimism and positivity is built around a certain company that traders have shorted, making it jump in value while short sellers are poised to lose profits.

A put option is a bearish trading strategy that provides you with the right to sell a stock at a specific price before expiration.

A trader buys the put option from the put seller at an agreed price called the strike price, getting the rights to sell the stock at that price no matter the market value. Apart from the premium the trader pays to the put seller, no other losses will be experienced. Not only is the strike price agreed upon, but also the expiration date of the put option.

The last term to know is stock price, that is, the actual market value price. If it drops below the strike price, your put becomes “in the money” and gains value. For example, if the strike price is $100 and the stock price drops to $80, the trader is in the money. Accounting for the premium $20 - $3 (premium), the trader has a profit of $17 per share.

However, if the stock price stays above the strike price, the trader’s put is worthless at the expiration date. For traders using short-selling specific platforms like TradeZero, it is important to understand other bearish strategies, such as put options, to gain a better understanding of short-selling.

Put options are mostly used for protection (hedging) and speculation that a stock will lose value. When hedging, traders buy a put option at a certain price, anticipating that it will lose value. However, by having put options, additional risk management strategies have been applied. Put options can help limit the losses.

For instance, if stock A is valued at $150, a trader can buy a put option at $140. If stock A drops to $120, the strike price is higher, meaning that the trader covered the position well.

Put options are also used for speculation, allowing traders to profit from a stock’s decline without short selling. Unlike shorting, which requires a margin account and carries unlimited risk, buying puts limits the downside to the premium paid. If the stock falls below the strike price, the trader can either sell the option for a profit or exercise it to sell shares at a higher price. This makes put options a low-risk, accessible bearish strategy favored by many retail investors.

Short-selling and put options are both bearish trading strategies that revolve around profiting from price devaluation. However, the similarities stop there. Short selling entails an obligation to sell the stock, while put options give you the right to sell the stock.

Put options have a limited maximum loss — it's simply the premium you paid to buy the option. In contrast, short-selling carries unlimited risk, since there's no limit to how high a stock’s price can rise before you're forced to buy it back.

When it comes to maximum profit, both strategies are capped in theory. A put option’s maximum profit occurs if the stock price falls to zero, giving you a gain equal to the strike price minus the premium. Short-selling also reaches its maximum profit if the stock drops to zero — in that case, you keep the full amount from the initial short sale. So, while both are capped by the stock reaching zero, the key difference lies in risk: puts have limited downside, while short-selling exposes you to unlimited potential losses.

Short-selling traders must have a margin account and collateral to cover the margin, which means higher capital. On the other hand, traders using put options only need to pay the premium upfront.

Short sellers are usually institutional investors, hedging funds, or traders with larger accounts, while options traders are more commonly seen as retail investors. Such traders with smaller accounts tend to choose put options due to defined risk and lower capital requirements. Institutional traders and hedge funds opt for short-selling because margin calls and large capital investments are not issues for those kinds of traders. Also, institutional traders partake in short-selling more often because they can make the unlimited risk of short-selling manageable by hedging against the position with other instruments, such as buying calls.

• Factor: Capital requirements
  Short-selling: High - requires margin account and often 50%+ of the trade value upfront
  Buying Put Options: Lower - you just pay the premium for the put contract (usually a few hundred dollars)

• Factor: Risk profile
  Short-selling: Unlimited risk - if stock price skyrockets, your losses can be massive
  Buying Put Options: Limited risk - max loss is the premium paid

• Factor: Time sensitivity
  Short-selling: Less time-sensitive, but risk increases the longer you're exposed Buying Put Options: Highly time-sensitive - options lose value over time (theta decay)

• Factor: Profit potential
  Short-selling: High - profit rises the more the stock drops
  Buying Put Options: High - limited by time and strike but can yield massive % returns with less capital

• Factor: Access to shares
  Short-selling: Requires finding shares to borrow (short locate) - not always available
  Buying Put Options: No shares needed - just market liquidity for the option

• Factor: Complexity
  Short-selling: Execution | Complex - needs margin, borrowing, possible forced buy-in
  Buying Put Options: Simple to enter/exit – just buy/sell the option contract

• Factor: Ideal for
  Short-selling: Traders with larger accounts and higher risk tolerance
  Buying Put Options: Traders with smaller accounts and defined risk appetite

Short-selling is a strategy that should be used when a trader wants direct exposure without time decay and premiums providing traders with direct dollar-for-dollar movement. For instance, when a trader is expecting a negative quarterly report or bad earnings in general, the trader will short the stock.

If a trader finds an overvalued stock, the short-seller will be inclined to short it, speculating that it will go on a steady and/or rapid decline. For instance, GameStop's short squeeze was due to media buzz and retail momentum—not market fundamentals. In today’s market environment, there can be many different factors which lead to a short squeeze.

Traders expecting a drop often use put options to limit downside risk. For example, after COVID-19, Zoom’s stock peaked due to high demand but declined sharply as normalcy returned. Bearish traders who bought puts during the peak, potentially profited as Zoom’s stock fell from around $300 to $100 over the subsequent two years.

Put options can be used as a safety net when a trader is expecting sudden volatility, usually before quarterly reports or event-driven moves. These types of hedging strategies can protect a trader’s portfolio from sudden and unexpected declines in stock price.