Two Ways to Bet Against a Stock
When you believe a stock will decline, you have two main approaches: short selling the shares directly, or buying put options. Each has distinct characteristics that suit different situations.
Short Selling Characteristics
Advantages
- No time decay - position can be held indefinitely
- Profits increase linearly as stock falls
- No premium cost (though borrowing costs apply)
- Can be closed at any time during market hours
Disadvantages
- Unlimited loss potential if stock rises
- Margin requirements tie up capital
- Borrowing costs can be substantial
- Risk of forced buyback if shares recalled
- Dividend payments owed to lender
Put Option Characteristics
Advantages
- Maximum loss limited to premium paid
- No margin account required
- No borrowing costs or dividend obligations
- Leverage - control more shares with less capital
- Can profit from increased volatility
Disadvantages
- Time decay erodes value daily
- Premium cost must be overcome to profit
- Limited liquidity on some ASX options
- Requires correct timing, not just direction
- Options may expire worthless
When to Use Each Strategy
Choose Short Selling When:
- You expect a gradual decline over time
- Borrowing costs are low
- You can monitor the position closely
- You have adequate margin capacity
Choose Put Options When:
- You expect a sharp decline in a defined timeframe
- You want to limit maximum loss
- The stock is hard or expensive to borrow
- You want leverage on your bearish view
Cost Comparison Example
Consider a $10 stock you believe will fall to $8:
- Short 1,000 shares: $10,000 proceeds, target profit $2,000, risk unlimited
- Buy 10 put contracts (strike $10): Maybe $500 premium, target profit $1,500 ($2,000 - $500), max loss $500
The put offers better risk/reward if correct, but loses 100% if wrong on timing.