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Buying Puts as an Alternative to Short-Selling

If you’re bearish on a stock, you can try to capitalize on this view in a few ways:

1. Sell the stock, if you own it.

2. Sell the stock, even if you don’t own it, by borrowing shares via your brokerage firm. Then, at a later date, buy the shares (hopefully at a lower price) to pay back your broker. That’s called "short-selling".

3. Or you can buy a put option, which gives you the right to sell stock at a given price for a pre-determined timeframe.

Why buy a put instead of selling short?

Short-selling can be tough. Short-sellers must contend with margin requirements and special rules about when they can or can’t place a short sale. Margin is essentially a line of credit for trading stock, for which you make a minimum down payment and pay your broker an interest rate. If the market moves against you suddenly, you may be required to quickly add to this down payment in what’s termed a “margin call”. Read up on the risks of margin to use this tool wisely.

If you’re wrong about your bearish outlook and the stock starts to rise, your risks climb considerably, too. You must deliver those shares of stock to the brokerage firm. Since there’s no limit on how high a stock price can climb, buying them when they’re on the rise means there’s theoretically no limit on your risk. Plus, you’ll continue paying interest on the margin balance until the position is closed.

Buying a put can offer a relatively low-cost, hassle-free alternative to short selling for bearish investors.

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