Short Selling vs. Put Options: What’s the Difference?

While many are familiar with buying stocks in hopes of profiting, the strategies for benefiting from price declines are often less understood. Two powerful tools in the bearish (pessimistic) investor’s arsenal are short selling and put options. These techniques, both aimed at capitalizing on downward price moves, are based on fundamentally different principles and carry distinct risk profiles.

Short selling, a practice dating back to the 17th century, involves borrowing shares and then selling them immediately, wagering on a price drop. Put options, a more recent financial invention, give investors the right to sell at a preset price within a specific time frame.

Below, we examine the mechanics, advantages, and risks of short selling and put options. We’ll explore how these strategies work, when and why investors might choose one over the other, and the pitfalls to avoid.

Key Takeaways

• Both short selling and buying put options are bearish strategies that become more profitable as the market drops.
• Short selling involves the sale of a security not owned by the seller but borrowed and then sold in the market, to be repurchased later, with the potential for large losses if the asset increases in price.
• Buying a put option gives the buyer the right to sell the underlying asset at a price stated in the option. The maximum loss is the premium paid for the option.
• Both short sales and put options have risk-reward profiles that may not make them suitable for novice investors.

Short Selling

Short selling is a bearish strategy that involves selling a security you don’t own, borrowing it, and hoping to reap profits by buying it at a lower price later. A trader will undertake a short sell if they believe a stock, commodity, currency, or other asset or class will take a significant move downward in the future. While often the subject of public scorn—you seem to be betting on companies to fail—in a broad sense, borrowing something to sell it later at a profit isn’t far from taking out a mortgage hoping to sell a home for more some years later.

Short sales can be used either for speculation or as an indirect way of hedging long exposure. For example, if you have a concentrated long position in large-cap technology stocks, you could short the Nasdaq-100 exchange-traded fund (ETF) to balance that.

The seller now has a short position in the security—as opposed to a long position, where the investor owns the security. If the stock declines as expected, the short seller will repurchase it at a lower price in the market and pocket the difference, which is the profit on the short sale.

Because of its many risks, short selling should only be done by experienced traders. 

Short selling is far riskier than buying puts. With short sales, the reward is potentially limited—since the most that the stock can decline to is zero—while the risk is theoretically unlimited, because the stock’s value can just keep climbing. Despite the hazards, short selling is a valuable strategy during broad bear markets since stocks decline faster than they increase. In addition, shorting carries slightly less risk when the security shorted is an index or ETF since the risk of runaway gains in the entire index is much lower than for an individual stock.

It’s also more expensive than buying puts because of the margin requirements. Margin trading uses borrowed money from the broker to finance buying an asset. Because of the risks involved, not all trading accounts can trade on margin. Your broker will require you to have the funds in your account to cover your shorts. As the price of the shorted asset climbs, the broker will also increase the value of the margin the trader holds. 

For experienced investors, choosing between a short sale and puts to execute a bearish strategy depends on investment knowledge, risk tolerance, cash available, and whether the trade is for speculation or hedging.

Put Options

Put options offer an alternative. When traders buy a put option, they buy the right to sell the underlying asset at the price stated in the option. The trader is not obligated to buy the asset secured by the contract.

The option must be exercised within the time frame specified by the put contract. If the stock declines below the put strike price, the put’s value will go up. However, if the stock remains above the strike price, the put will expire worthless, and the trader won’t need to buy the asset.

While there are some similarities between short selling and buying put options, they have different risk-reward profiles that make both unsuitable for novice investors. That said, buying puts is much better suited for the average investor than short selling because of the limited risk. Understanding their risks and benefits is essential to learning about scenarios where these two strategies can maximize profits.

Put options can be used either for speculation or for hedging long exposure. Puts can directly hedge risk. For example, if you were concerned about a possible decline in the technology sector, you could buy puts on the technology stocks held in your portfolio.

Buying put options also has risks, but not as potentially harmful as shorts. With a put, the most you can lose is the premium you have paid for buying the option, while the potential profit is high.

Puts are particularly well suited for hedging the risk of declines in a portfolio or stock since the worst that can happen is that the put premium—the price paid for the option—is lost. A loss would come if the anticipated decline in the underlying asset price didn’t materialize. However, even here, the rise in the stock or portfolio may offset part or all the put premium paid.

Also, a put buyer doesn’t have to fund a margin account—although a put writer has to supply margin—meaning that one can initiate a put position even with limited capital. However, since time is not on the side of the put buyer, the risk here is that the investor may lose all the money invested in buying puts if the trade doesn’t work out.

Implied volatility is a significant consideration when buying options. Buying puts on highly volatile stocks may mean paying exorbitant premiums. Traders must ensure the cost of buying such protection is justified by the risk to the portfolio holding or long position.

Short Selling and Put Options Are Not Always Bearish

Short sales and puts are essentially bearish strategies. But just as in mathematics, where the negative of a negative is a positive, short sales and puts can also be used for bullish exposure.

For example, suppose you are bullish (positive) about the S&P 500. Instead of buying shares of the S&P 500 ETF Trust (SPY), you initiate a short sale of an ETF with a bearish bias on the index, such as the inverse ProShares Short S&P 500 ETF (SH) that moves in the opposite direction of the index. Thus, if you have a short position on the bearish ETF and the S&P 500 gains 1%, your short position should gain 1% as well. However, this is not a long-term strategy.

While puts are generally associated with price declines, you can do a short position in a put—known as “writing” a put—if you are neutral to bullish on a stock. The most common reasons to write a put are to earn premium income and to acquire the stock at a price lower than its present one.

For example, let’s assume XYZ stock trades at $35. You think this price is overvalued, but you would be interested in acquiring it for a buck or two less. One way to do so is to write $35 puts on the stock that expire in two months and receive $1.50 per share in premium for writing the put.

If the stock doesn’t decline below $35 in two months, the put options expire worthless, and the $1.50 premium is your profit. Should the stock move below $35, it would be “assigned” to you—meaning you are obligated to buy it at $35, no matter the present trading price. Thus, your effective stock is $33.50 ($35 – $1.50). Of course, the mathematics of this ignores trading commissions and other fees you would need to account for in any strategy you use.

Short Sale vs. Put Options Example

Let’s use Tesla (TSLA) as an example to illustrate the relative advantages and drawbacks of using short sales versus puts.

Tesla has plenty of supporters who believe the company still has much farther to climb as the world switches to electric vehicles. But it also has its detractors who have questioned whether the company’s market capitalization of over $662 billion—as of August 2024—is justified. Of course, the events of 2020 are still seared in the brains of short sellers who remember the $40 billion those betting against TSLA’s rising price lost that year.

Nevertheless, 2020 was years and a pandemic ago, and we’ll assume for the sake of argument that our trader is still bearish on Tesla and expects it to decline significantly by the end of the year. Here’s how the short-selling versus put-buying alternatives stack up:

Sell Short TSLA Shares

• Assume 100 shares sold short at $220
• Margin required to be deposited (50% of total sale amount) = $11,000
• Maximum theoretical profit—assuming TSLA falls to $0—is $220 x 100 = $22,000
• Maximum theoretical loss = Unlimited

1. Scenario 1: Stock declines to $100 by the end of the year, giving a potential $12,000 profit on the short position ($120 x 100 shares).
2. Scenario 2: Stock is unchanged at $220 at year’s end, with $0 profit or loss.
3. Scenario 3: Stock rises to $500 by year’s end, creating a $28,000 loss ($280 x 100).

Buy Put Options on TSLA

Now instead assume buying one put contract (representing 100 shares) expiring at the end of the year with a 220 strike and a premium of $25.

• The margin required is none.
• Cost of put contract = $25 x 100 = $2,500
• Maximum theoretical profit: Assuming TSLA falls to $0 is $220 x 100, less the cost of the put = $22,000 – $2,500 = $19,500
• The maximum possible loss is the cost of the put contract: $2,500.

1. Scenario 1: Stock declines to $100 by December, there is a $12,000 nominal gain in the option as it expires with $120 in intrinsic value from its strike price (220- 100), worth $12,000 in premium. However, since the option cost $2,500, the net gain is $9,500.
2. Scenario 2: Stock is unchanged; the entire $2,500 is lost.
3. Scenario 3: Stock rises to $500; the entire $2,500 is lost, but no more.

With the short sale, the maximum possible profit of $22,000 would be gained if the stock plummeted to zero. Meanwhile, the maximum loss is potentially infinite should the stock keep rising and rising.

With the put option, the maximum possible profit is cut to $19,500 but the maximum loss is restricted to the price paid for the put.

Note that the above example doesn’t consider the cost of borrowing the stock to short it, as well as the interest payable on the margin account, both of which can be significant. With the put option, there is an upfront cost to buy the puts. However, there are no other ongoing expenses.

In addition, the put options have a finite time to expiry. The short sale can be held open as long as possible, provided the trader can put up more margin if the stock appreciates in value and assuming that the short position is not subject to buy-in because of the large short interest.

Can You Short Sell Options?

Yes, short selling involves the sale of financial instruments, including options, based on the assumption that their price will decline.

Can I Short Sell Put Options?

Yes, a put option allows the contract holder the right, but not the obligation, to sell the underlying asset at a preset price by a specific time. This includes the ability to short sell the put option as well.

What Is Long Put and Short Put?

A long put involves buying a put option when you expect the underlying asset’s price to drop. This play is purely speculative. For instance, if Company A’s stock trades at $55, but you believe the price will decline over the next month, you can make money from your speculation by buying a put option. This means you’re going long on a put on Company A’s stock while the seller is said to be short on the put.

What Is a Short Position in a Put Option?

A short position in a put option is called writing a put. Traders who do so are generally neutral to bullish on a particular stock to earn premium income. They also do this to buy a company’s stock at a price lower than its present market price.

The Bottom Line

Short selling and put options are strategies to profit from a decline in a stock’s price, but they differ significantly in their approach and risk profile. Short selling involves borrowing and then selling shares immediately, hoping to repurchase them at a lower price to return to the lender. This strategy offers potentially significant profits should the stock price fall but also carries unlimited risk if the stock price rises. Short sellers are also responsible for paying dividends and may face margin calls or difficulty finding shares to borrow.

Put options, meanwhile, give the buyer the right to sell a stock at a specific price (strike price) within a set time frame. The investor pays a premium for this right, representing their maximum potential loss. Put options offer high leverage and limited risk, making them attractive for bearish investors or those seeking portfolio protection. However, options expire, and their value decays over time. Despite their risks (higher in short selling), both strategies can be effective in a bear market.