Shorts vs. Puts

Discussion in 'Options' started by bluedemon77, Jun 19, 2006.

  1. bluedemon77

    bluedemon77 Guest

    Sorry for asking an elementary question, but I've never traded options and I'm trying to understand them, so I hope one of you guys will help me out.

    Let's say I think UAUA is going to start falling again, which I do. The stock closed at $31.60 and if I short it I think I can cover it in a few days for $26, giving me a profit of about $5.50 per share. If I'm wrong and the stock skyrockets, theoretically my losses are unlimited. Also, there is a possibility that I can be forced to cover my short by the broker at any time, regardless of where they are in the market. Plus you can't short a stock under $5 and stocks are not always available to short.

    Or I can buy a $30 July put contract for $1.20 per share and if the stock hits $26 I'll make $2.80 per share. But if I'm wrong, the most I can lose is $1.20 per share. Essentially I'm trading off potential gain in return for limiting my loss.

    Did I get that right? Are there any other advantages to buying puts instead of shorting stock?

  2. If you want to short without as rigid a time limit, you could also just short the stock and buy a slightly out of the money call (maybe 1 or 2 months out) as insurance (just in case). So if the stock goes up $5, you'll lose significantly less. The out of the money call will pay for itself if the stock drops just a little bit as you predict.
  3. Short stock + long call = synthetic put.

    You still might be better off just buying the long put and avoiding margin requirements, paying dividends if stock issues them, getting called out of your short early by your broker, or margin interest. Buy the put and keep the rest of your capital safe.

    To replicate a short you can simply use a deep ITM put to get as much delta as possible.

  4. bluedemon77

    bluedemon77 Guest

    Thanks for the responses, guys. I think this might be one of my first option trades when I get my IB account set up tommorrow. UAUA looks like it's starting to slip. I have faith in this company--failing, that is.
  5. TOS lists UAUA as "Hard to borrow" so you might not be able to short it.

    Also, if you buy the put and it goes to $26 you should make more than 2.80 due to time value and volatility, depending on which expiration you buy. For example, right now the Jul 35 puts are selling for about 3.30 and UAUA PPS is 32.50, so the options are priced about 80 cents higher than the difference. If you hit your target you should probably close the position.

    If this is your first option trade you don't want to keep it until expiration. If you don't close an ITM put, it will automatically be exercised and your broker will sell "your" shares. If you don't have any shares you will be short the shares. If some good news for UAUA is announced over the weekend after expiration, and it gaps open on Monday, you will have to buy them and possibly have a loss.

    BTW, right now the July 30 puts are selling for about .85.

    Yet ANOTHER consideration is liquidity. Open interest on the Jul puts is 1,111, but trading volume today is only 5 contracts, and the bid/ask spread is .30.
  6. BTW, I asked a TA guy I know who said it might be a good short if it passes 33 resistance. Then it will be overbought. Just passing this along FYI.