Following up on Put Options: A Deeper Dive, when we discussed that put options give the investor the right to sell a security at a specific price up until a specified expiry date this week we’ll discuss shorting a stock.
Short selling is a short term investment strategy used by investors that utilizes borrowed stocks, and selling the borrowed security, expecting that the share price will fall.
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A bearish position that speculates on the decline in a stock or other security’s price, you might short a stock if you feel strongly that its share price was going to fall.
To short a position, you borrow shares that you don't own and ideally profit by selling them to another investor. Since a company has a limited number of shares outstanding, a short seller must first locate some of those shares to sell them, usually from a broker.
Shorting, if used at all, is best suited as a short-term profit strategy. There's no theoretical limit to the losses you can suffer. For instance, if you sell 100 shares of stock short at a price of $10 per share. Your proceeds from the sale will be $1,000.
If the stock goes to zero, you'll get to keep the full $1,000. However, if the stock soars to $100 per share, you'll have to spend $10,000 to buy the 100 shares back.
Shorting stock requires a margin account, which is subject to the rules of regulatory bodies, such as the Federal Reserve Board and the Financial Industry Regulatory Authority (FINRA), and securities exchanges, such as the NYSE and Nasdaq.
Traders must account for any interest charged by the broker or commissions charged on trades.
An alternative to shorting that limits your downside exposure is to buy a put option.