How to Short a Stock Without Infinite Risk

How to Short a Stock Without Infinite Risk


Many traders are very hesitant to short a stock because while a stock you are long can only go to zero a stock you are short can go to infinity. While I have never personally seen a stock go up to infinity Apple’s run this year and the internet stocks of 1999 did make a run for growing to the sky. My number one concern above all else us to manage my risk. The best way that I manage my risk is with asymmetric trades. Limited downside unlimited upside. I wanted to short Price line when it was at $650 after the TRIP earnings fiasco and plunge and before fear set in over the Expedia earnings. So did I borrow and sell short 100 shares for $65,000 in margin? No, instead I bought a weekly in the money put option with a $660 strike  for $1,500 to control 100 shares of Price line to the down side. I had $1,000 in intrinsic value and $500 in time value. What was my total risk? $1,500. What if Price reversed and went up $30 a share? I would lose $1,500, what if it went up $55.67 a share in one day? I would lose $1,500 a share. But what if it plunged $30 a share? I would gain $3,000 in intrinsic value. What if it went down $55.67 in one day? I would gain $5,567 in intrinsic value. As you can see a put option has a built in stop and is designed to let winners run and cut loser short by its very structure. Why would anyone risk $65,000 when they can risk $1,500? The key to option trades is they must be liquid so the bid ask spreads do not cost you too much to get in and out of. Also you have to be sure that the expense of the volatility priced in above intrinsic value does not take away the potential profits from price moves becasue it is already priced in. I trade with in the money options so I trade it like a stock with intrinsic value and do not have to overcome the time value very much. By just holding stock short during this $55.67 run by Price line it could have been very damaging to an account with out a set stop loss to cover quickly Friday morning. A put buyer already had their risk defined for little stress.

In this trade I actually sold my $1,500 put at the end of day before Expedia’s earnings. (This is time stamped on my twitter account along with all my trades in real time.).  I do not bet on earnings. I did open a weekly in the money call option the next morning when Price line zoomed up to $660 for the second time the next morning following its brother Expedia’s earnings. Once again creating an asymmetric trade with an unlimited upside limited downside.

How to Short a Stock Without Infinite Risk