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What advantage are there to shorting the stock as opposed to buying put option : finance

Buying a put is a cash outflow, while shorting is an inflow. One advantage is that you can reinvest this inflow into another position.

In both cases you're hoping to profit, and have money flow INTO your account, from a stock price's decrease.

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When you buy a put option, you're taking possiession of something from someone else, and paying for it.

When you short, you're borrowing shares, and selling them, which brings cash in for you.

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Options are essentially like insurance. If you buy insurance you pay a premium. If you sell it you earn the premium (provide insurance).

A put option is guaranteeing you a certain (strike) price even if the market value drops below the strike. In that case, the owner of a put (who is long or bought the option) paid for the right to sell at a predetermined price.

A call option allows the owner (who is long or bought it) to buy at a certain (strike) price. So even if the prevailing market price is above that value you can buy it cheaper.

In both cases the option buyer has bought a right that they can use if the market moves. The option seller only earns the premium and needs to honour the contract if it is profitable to exercise for the owner. Similar to insurance companies again, where the best scenario for the seller of insurance is that there will not be a claim (and they keep the premium).

@Regio's answer is wrong. If you are short a put, you sold a put. You cannot hope for any future profit as you are selling the right to sell to someone.

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  • $\begingroup$ Regio's answer is poorly worded (insufficient details) but not necessarily wrong. You can make money to the downside by buying a put or selling a call and to the upside by buying a call or selling a put. And while an owner of a call can buy buy the underlying cheaper if the prevailing market price is above that value (strike price), that doesn't guarantee profit. $\endgroup$ Sep 18 '21 at 15:07
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There are advantages and disadvantages for each:

SHORT STOCK

  • Requires requires 50% margin overnight (US) but only 25% intraday for a Pattern Day Trader (unless your broker requires more)

  • Stocks aren't always borrowable. If they are, the borrow cost may be next to nothing (0.25%) or it can be significant (>500%)

  • The delta of stock is 100 so without margin, it's a dollar for dollar gain or loss as the security moves up or down. Margin leverage just multiplies the ROI in either direction.

  • The Alternative Uptick Rule is triggered when a stock experiences a price decline of at least 10% in one day. That may hinder your ability to open a new or add to an existing short position.

  • The potential loss for a short seller of stock is unbounded (but no stock has ever gone to infinity).

  • If you are short the stock on an ex-dividend date, you pay out the dividend to the lender of the shares

LONG PUTS

  • Must be paid for in full. The most that you can lose is the cost of the option.

  • Options are a wasting asset so time decay (theta) erodes your position. Your window of opportunity is limited by expiration.

  • Options can inflate in value if implied volatility expands and can lose value if it contracts, regardless of share price.

  • Option B/A spreads tend to be wider than for equities, particularly for deep ITM options. Pending dividends inflate the cost of a put and must be factored into option strategies calculations.

  • Many options are illiquid and trade by appointment (low Open Interest). If so, B/A spreads can be very wide.

  • Options have a delta of zero to 100. Deep ITM puts with a delta of 100 mimic the stock and P&L will be 1:1 to the downside but the loss ratio will decrease as the price of the security rises as the put's delta decreases. ATM puts have a delta of about 50 so on a 1:1 basis, initially you'll make 50 cents on the dollar as the security drops, so initially, you'll need 2x as many puts to duplicate the return of the short stock.

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Though you might buy or short an option in both cases hoping to make a profit, the question is whether today you have to pay money in order to participate in the investment (this is the case if you buy an option), or whether you receive money today to get into the investment (like when you short an option).

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  • $\begingroup$ Short a put (similar logic for calls) means you sold the right to sell. There is no possibility for future profits. Only your counterparty could profit if prices decline below the strike and the option is in the money at expiry (or early exercise in the case of American options). $\endgroup$
    – AKdemy
    Sep 17 '21 at 6:12
  • $\begingroup$ @AKdemy - If you sell an option, your potential future profit is the premium received. That is a real possibility. $\endgroup$ Sep 18 '21 at 15:08

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