Here's a hypothetical situation. You short some >$20 stock for a few days, for a total of say 3% of your capital - a pretty safe trade overall. But then due to either 1) an error on the exchange, the broker, or anywhere in between 2) lack of liquidity 3) trader error the stock jumps some ridiculous amount and stays there for some time. For example, some large trader's software went haywire and placed a ridiculously large bid and ate up all the asks, then an automated spread ask comes in, and all of a sudden the stock is valued at 100x what it was the day before. And if this situation persists for longer than whatever the auto liquidation period is (10 mins for IB), your entire account gets liquidated and that short position gets liquidated at the new 100x price. And now you blew your entire account and you might owe money to the broker. Granted, this situation is very extreme and highly unlikely, but it's not impossible. Just like healthy stocks dropping to $.01 during the Flash crash was highly unlikely. And during a lifetime of trading, with tens of thousands of trades, it would take only one such anomaly to bankrupt you. There's another, much older thread that also talks about a hypothetical situation that could potentially blow your entire account due to margin: http://www.elitetrader.com/vb/showthread.php?threadid=198220 This type of scenario can only happen with short/margin positions. With long only positions, you just have to wait out the madness. What do you guys think, is that a reasonable concern? Do you protect yourself from something like that? Do you use margin/shorting at all?
To my memory, I've only seen an extreme example once. VOLKSWAGEN stock in Germany was hard to borrow because Porsche owned a large block of stock and something was happening, that I can't remember. I attached a graph of what happened to the shares. This is very rare and something you can plan for. A true Black Swan event.
I'm no expert on options, but I don't think that's a valid alternative. Puts trade on a much lower volume than the underlying stock. If the stock is not very liquid to begin with, there might not be any puts. And even if there are puts, the bid/ask spreads are much higher. There are also added variables that you have to deal with, like the added cost for it being an option and the added cost for volatility. You mean that if you complain to the broker, they will cancel the short trade? When would they do something like that? And what about the other long positions that they would liquidate at the market price? I know that the exchange busted the Flash Crash trades, but that was only because there were a lot of stocks that were acting up and so many people were involved.