Going long a stock that’s up substantially in a short period of doesn’t make too much sense when you really think about it. However, if you’re not a buyer, it doesn’t mean you have to automatically become a short seller either.
Short sellers know that risk management is of highest priority. Initiating smaller than usual positions for short ideas will certainly help, however, it’s not enough to prevent any disasters if a stock opens up significantly above the stop loss.
Luckily, there are indeed some alternatives to equity short selling. These alternatives will allow you to have more control over risk management and help you prevent any potential calamities.
Buying Long Puts
If you really want to bet against a stock, you should look into buying put options. By doing this, you’ll gain the rights to sell the stock in question by a certain time at a certain price. In order to get that privilege, you’ll naturally have to pay more money to the seller who assumes the risk and is obliged to buy that certain stock from you at a predetermined price.
When compared to shorting stocks, this gives you a number of advantages. For instance, with buying puts, in worst case scenario, you’ll lose the premium you already paid in advance. Compare this to short selling, your possible losses are almost unlimited. Another big problem with short selling is that you won’t be able to do it anytime you want.
In certain cases, the stocks you want to short are hard to find. As a matter of fact, some brokers have a difficulty finding shares to lend out. What’s more, the Securities and Exchange Commission can even take action and stop investors from shorting some organizations. In the past, we saw this happen with JPMorgan and Bank of America. Lastly, buying a put won’t require paying periodic dividends, which will help you a lot.
An inverse ETF uses certain methods in order to produce a performance on a daily basis, which is in the opposite direction of a certain index. These funds usually have a one-to-one correlation with the targeted index. Alternatively, they can also be leveraged. Along with other ETF’s that use derivatives, inverse ETFs aren’t used as long-term investments.
One of the biggest advantages Inverse ETFs have over short selling is that they don’t need the investor to hold a margin account. Also, you can use certain inverse ETFs to profit from declines in broad market indexes. Furthermore, you can even buy inverse ETFs that are focused on a specific sector like energy, financials or even consumer staples.
Additionally, short sells require you to pay a stock loan fee to the broker who you’re borrowing shares from in order to start. Stocks with high short interest can even result in difficulty to find shares to short. This drives the costs up and in most cases, the cost of borrowing can surpass 3% of the amount that’s borrowed. On the other hand, most inverse ETFs have expense ratios of below 2%.
In the End: Be Careful as Possible
No matter which one of these options you go with, you have to keep in mind that the market doesn’t always function logically – quite the opposite actually – and that every option has a limited life. Even things you think are certain can take a long time to occur. Therefore, you have to be at ease with the risks involved before you make buys, sells or trades.