Here's the Video Transcript:
Hey everyone! In this video, I want to talk to you about the best way to short stocks using options. We’re going to go over five different strategies and then we’ll go to the platform to take a look at a real example. Strategy number one would be to simply short the stock. The advantage is that there’s no expiration date. We know that every option expires at some point in the future, but if you’re simply shorting the stock, you don’t have the expiration date to worry about. The disadvantages are, one, it requires a lot of capital. You’re having to put up a lot of capital just to sell that stock. If you have a margin account, you may only have to put up a portion of that capital, but it still requires a lot. Second, the risk is undefined. Theoretically, a stock can keep going up, up, up and up forever. Now, we know that that’s not realistic, but there are times when stocks can have explosion moves to the upside and that’s your main risk.
Third, you can’t short stock in an IRA. Unless you have a margin account, you’re not even able to short stock. Fourth, it’s a 50/50 bet. As I’ll show you on the platform, when you’re just simply selling stock, there’s no probabilities in your favor. It’s really just a 50/50 bet. And there’s no premium decay. You don’t have theta component, giving you that time decay that options give you. Strategy two. You could buy a put. You could long a put. The advantages are that there is minimal capital required. You have to put up a lot less capital to simply buy a put. Second, they are tradable in an IRA or a margin account. Either one is fine. The upside profit potential is still unlimited, so you still have that undefined profit potential and your downside risk is defined, so you know exactly how much you’re taking on as risk when you put the trade on. The disadvantages are that they have negative theta. That premium decay is working against you.
Every day that you hold that position, that premium decay is working against you. Because of that, it makes it less than 50/50 bet, not in your favor. Strategy three. You could buy a put vertical. The advantages are there’s minimal capital required, you can trade these in an IRA or a margin account. The downside risk is defined, so you know exactly what your risk is at order entry, and they can be a higher probability than simply shorting stock if you set them up correctly. The disadvantages are that you have upside profit defined, so you’re capping your downside but you’re also capping your upside potential.
Strategy four. You can sell a call or short a call. The advantages are that it takes minimal capital compared to just shorting the stock. It gives you a much higher probability of success than shorting the stock and you have that positive theta decay, that premium decay working in your favor. The disadvantage is that the upside profit is defined, so you’re capping your upside, and the downside risk is undefined. If that stock keeps moving up, up, up and up, that’s going to be hurting that position.
Selling calls is not eligible to trade in an IRA. Strategy five. Short call vertical. The advantages are minimal capital required. You can trade them in an IRA or a margin account. The downside risk is defined, so you know exactly what your risk is when you enter the trade, and you can set them up as higher probability trades than simply shorting the stock. Disadvantages, again, you have upside profit that’s defined. You’re capping your upside. Let’s go to the platform and I’ll tie this all together and make sure it makes sense for each strategy. The stock that we’re looking at in this example is Facebook, ticker FB. You might look at this chart and say, “Okay, Mark Zuckerberg, you’ve got a great company. It’s been really powerful. The stock has performed really well. It’s trading at all time highs at over $165 per share, but I think it’s going to pull back in the near future.” What goes up must come down, right? If you take that assumption, then you want to figure out, okay, what’s the best trading vehicle? What’s the best strategy for me to use to get short Facebook? Let’s take a look at the different examples and go through each one to see what makes the most sense.
The first strategy we’ll look at is selling stock. I’ve clicked the box down here where we show selling 100 shares of Facebook stock at the current market price, which is about $165.29. If we put our price slides to right where the stock is trading right now, you can see it shows the probabilities on the downside, about 49% and the upside, about 50%. Like I said, it’s about a 50/50 bet whether you’ll be profitable on this trade or not. As far as the amount of capital, because it’s trading at $165.29, you’re going to need to put up $16,529 to short 100 shares of Facebook. That’s a lot of capital. Again, if you have a margin account, you have to put up a portion of that but it’s still a large amount of capital to put up just to short the stock.
The next strategy we talked about was just simply buying a put. If we’re going to buy a put in navigation trading, we’re going to do a deep in the money put to minimize that negative theta decay. This is about an 80 delta put, which is pretty deep in the money but you can still see the difference between the pink line, which is our current profit line and the teal line, which is expiration, is about 164, if you watch this number down here, it’s about 164, $165. Price just sat right here between now and expiration. We lose $165 or another way to look at that is if you look at the theta, you’re losing about $3.82 a day if the stock just sits there. It needs to make a move in your direction fairly quickly for you to profit. The more it moves against you, the more negative that theta gets as you can see the theta number continues to go down as I move the hash mark. One of the advantages as I mentioned though is you’re putting up a lot less capital, whereas to short the stock, you’re putting up over $16,000.
To buy one put, you’re simply putting up a little over $1,600, so about 10% of the value of actually shorting the stock. The next strategy we looked at was buying a put vertical. This is simply, we’re buying a put vertical and I’m taking the strikes that are straddling both sides where the current price is. Current price is about $165, so I chose the 170 and the 160. What this does for us, it simply it’s about 50/50 probability of success. However, we’re capping our downside risk to $485 per contract and the upside potential is $515.
This is simply a short stock replacement and it expires in the future. This could be an option depending if you are in a period of low implied volatility or high implied volatility. The next option would be to sell a call. Again, you can’t do this in an IRA, but if you have a margin account, you could sell calls in Facebook to take a short buy as position. What you’ll see if we move the hash mark to our break even point, you can see we got to change this calendar to the expiration date, which in this case is 9/16. Now this has about a 75% probability of success, so if price just stayed right here or moved even up, all the way up to 177.89, we can still make money on this trade. So it gives you a very high probability of success. Now, if Facebook continues to explode to the upside, that’s where our risk lies. So you can see this risk and you can kind of see the potential loss depending on how high Facebook got.
You’re trading off that high probability of success for that upside risk. The next and last strategy would be to sell a call vertical. This should be done again in high implied volatility and the difference is if you don’t like that unlimited upside risk that you had with just a short call like we just showed, you can define that upside by doing a short call vertical. By doing this, you’re lowering your probabilities a little bit and you’re lessening your max profit, in this case the max profit for one short call was $290 and with this it’s 177 because the amount of credit that you receive. But for giving that up, you are capping your downside risk. No matter how high Facebook were to charge, no matter how high it were to go, the most you could lose on this trade as you can see is $823. That would be at this level here. There’s no right or wrong strategy. It depends on a variety of factors. One, where’s implied volatility? If implied volatility is high, we want to be net sellers of options. If implied volatility is low, we want to be net buyers of options.
We want to be cognizant of the amount of capital that we have in our account and figure out what the best strategy is. Also, are we trading in an IRA or a margin account? These are all factors that come into play along with the other positions that we have in our account. I hope this was helpful. If you’d like to learn more about the different strategies that we use to make consistent returns, come see us as NavigationTrading.com. We’ve got a ton of free resources including the Navigation Watch List, which is a list of the most profitable symbols to trade for each type of strategy.
We’ve got the Volatility Indicator, which you’ve seen on My Chart. You can download this directly to your ThinkorSwim Trading Platform. We’ve got a free options course called Trading Options for Income, which is a step by step guide to get you making consistent trades right away. We look forward to seeing you there..
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