While most traders don't typically short stock, there are situations where using short stock can be beneficial in neutralizing your portfolio if it gets too long. However, shorting stock outright is capital intensive with margin. Today we'll show you how you can use options as a way to go synthetically short a stock with a fraction of the capital requirement.
In this video tutorial, we’re going to help you understand how you can go synthetically short a stock position with about 1/4 of the capital that's typically required using options.
While most traders don't know that you can typically short stock, there are many situations where using short stock can be beneficial in neutralizing your portfolio if it gets too long or you’ve got too many bullish positions in your portfolio.
However, shorting stock outright is very capital intensive with margin. And today, we’ll show you how you can use options as a way to go synthetically short a stock with 1/4 of the capital requirement.
How do we do this or setup this strategy? Well, it’s pretty easy. Basically, what we’re going to do is we’re going to buy an at the money put option which is as close to where the stock is trading right now as possible and at the same time, right across the option chain, we’re going to go ahead and sell an at the money call option at the same strike.
This will ideally get us synthetically short the stock at that strike price. What’s the risk? Just as with a traditional short stock position, you do have unlimited risk should the stock continue to rally higher into expiration.
We’re not trying to change anything here. We’re just trying to use our capital a little bit more efficiently but create the same profit and loss diagram.
As far as profit potential goes, because you are emulating a short stock position, you have an unlimited profit potential up until the expiration of the options that you trade. Assuming that the stock goes down, really, it’s limited to the stock going to zero of course.
Breakeven points are pretty easy to calculate with this trade. You take the long strike price, and you subtract out the debit that you paid. If you received a credit, you would take the long strike price plus the credit that you received in doing the strategy.
Let’s go to our broker platform here on Thinkorswim. We’re going to use GLD. We’ve used this one for another video as well just because the stock is real, really high right now and we could see ourselves shorting something like this or at least getting bearish on a trade like GLD.
If we go into our analyze tab, we can look at shorting the shares outright. The stock is trading about 124.93, so we’re just going to round it up to about 125 to make the math a little bit easier for everyone on this video.
You can see as soon as I hit confirm and send, if we were to short the shares outright at 125, 100 shares, it would cost us as far as our buying power reduction about $12,500, so pretty capital intensive to be able to do this type of position.
It reduces our buying power dramatically in this trade. One of the ways that we can do it on the other side is to go ahead and use those short options.
What we’re going to do here is we’re going to buy an at the money put, we’re going to buy the at the money put that's at 125 and then we’re going to go across the chain here and do the same strike price, only this time, we’re going to sell the call option.
In this case, we’re going to go synthetically long, and you can see it's just a $.7 debit. When I hit confirm and send for this trade, you can see that the cost of this trade here is $9.50 that we’re going to receive a credit here, but really, what the broker is going to hold in margin is $2,700.
This is obviously a lot less than the $12,000 that it was going to cost us originally to sell the shares short, so you can see how using this type of option strategy is beneficial in reducing the cost of selling these shares short and going bearish on the underlying stock.
Some of the key takeaways are that these are great alternatives to shorting the stock outright because they carry such a low capital requirement, but don't let the smaller investment blind you to the massive risk that you're still taking with this strategy.
With this strategy, we’re trying to replicate the profit and loss diagram of a short stock position. This doesn't mean that we are taking less risk. It just means that we’re using less capital to get into the position.
We’re leveraging the power of options to create this strategy. It does not mean that we’re taking less risk, so make sure that you understand how that all works out and where you can and can’t lose money as the stock trades in the future.
As always, I hope you guys enjoy these videos. If you have any comments or questions, please ask them right below on the lesson page. Until next time, happy trading!