Jon Lewis

The Best Way to Short Stocks

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Another problem with shorting is that there's no guarantee that the stock will be available in your broker's inventory. So your shorting choices may be limited.

Learn more about the issues with shorting stocks.

The Advantages of Put Options

The alternative to shorting is to buy a put option.

A put gives you the right, but not the obligation, to sell the underlying stock at the strike price on or before expiration. Buying a put allows you to lease the downward price movement of a stock.

If a stock is priced at $50 and you buy a 50 strike put, you have the right to sell 100 shares (you either own the shares already or buy them at the market price) of the stock at a price of $50 per share no matter how low the market price. If the stock drops to $40, you can buy 100 shares for $4,000 and sell them for $5,000 using your put. That's one way to realize a gain.

The other way is to sell your put option for a profit. If you buy a 50 strike put for $2 ($200 per contract) and the stock drops to $45 at option expiration, your put is now worth $5 ($500 per contract). That's a 150% profit on your initial investment.

Contrast that to shorting a stock at $50. If the price declines to $45, you make $5 per share for a 10% return. This points out one of the main advantages of options -- leverage, or more bang for the buck.

The other primary advantage of buying a put is that you're placing far less cash at risk. Shorting 100 shares of a stock at $50 requires a margin account and an investment of $5,000. But buying a put may require only a few hundred dollars. And the most you can lose is limited to the premium paid for the option.