How To Short Stocks Without Taking On Undue Risk

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There’s a common saying on Wall Street: “Bulls make money, bears make money, and pigs get slaughtered.” In other words, you can make money in the market whether it’s going up or down but getting too greedy could erase any profits you had up until that point. It sounds good, but many investors get stuck at the “bears make money” part. After all, it’s relatively easy to profit from bull markets, but profiting from bear markets isn’t quite as simple.

In order to make money in a bull market, all one needs to do is buy low and sell high. Easy enough when markets are trending higher. But in a bear market, the same principle is applied in reverse: sell high, buy low. Luckily, there are a number of various strategies you can employ to profit from down markets without taking on more risk than you’re comfortable with.

Bear strategies for any portfolio

The simplest way to profit from a bear market is to simply short a stock. You sell a stock upfront, pocketing the money, with the intention of buying the stock back after it falls in value. However, this strategy comes with a high degree of risk since a stock can only fall to $0 resulting in a 100% theoretical loss, but there’s no limit to how high a stock can climb.

Instead, investors may choose to utilize options to take advantage of falling stock values. Buying a put gives you the right, but not the obligation, to sell 100 shares of a stock at a given price. That means that if the stock does fall, you can exercise the option and take the profit. But if the stock goes higher instead, you simply let the option expire to worthless and your only loss is the cost of the put itself.

Another option strategy you can use is called a bear put spread. Let’s take a look at how this is accomplished. Assume there’s a stock trading for $50 per share and you think it will drop in value. You purchase a put at a strike price of $50 per share and offset the cost by selling a put with a strike price of $40 per share. If the stock falls, your maximum profit is the spread between the $50 strike price and $40 strike price. If the stock rises or does nothing, you’re simply out the cost of the put option which was already partially offset by selling another put.

Finally, you can profit from bear markets with a credit call bear spread. Taking from our example above, instead of purchasing and selling puts on the stock, you use calls. In this case, you would sell a call with a strike price of $50 and buy a call with a strike price of $55. This limits the total downside to the spread between the two should the stock rise in value. If it does nothing or drops, you keep the upfront credit you gained from selling the call minus the cost of the higher strike price call.

Final considerations

No matter which strategy you use, profiting from a bear market isn’t hard to accomplish. By using options to mitigate risk, you don’t have to worry about higher-than-expected losses compared to investing in a bull market. Bear markets don’t have to be a time when your portfolio’s returns lag – make the most out of bear markets with these strategies.