What financial instruments are there that are profitable when an underlying assets falls?
Are they available for IPOs?
Are they available for foreign stocks?
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3This is one of the y things that can be done with options. Be careful; options generally are not positive sum and mean you are playing against experts; if you don't see the sucker at the poker table, he's sitting in your chair.– keshlamCommented Apr 1, 2016 at 15:17
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3As @keshlam notes, buying puts (or selling calls if you feel the fall will occur slowly) is one option (ha ha, get it?). Selling short is another.– user1731Commented Apr 1, 2016 at 16:24
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@barrycarter I'd advise against selling calls since risk is unlimited. The only reason to use options to profit on a downfall is the limited risk of a long options position. Otherwise he might as well straight-out short the stock. Short options positions are a great way to lose a lot of money really fast.– TainToTainCommented Apr 4, 2016 at 18:28
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@TainToTain My mistake, sorry. I meant to say selling covered calls (if you feel the fall will occur slowly enough that the income from calls will exceed the loss in the stock price).– user1731Commented Apr 4, 2016 at 18:39
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4 Answers
Aganju has mentioned put options, which are one good possibility.
I would suggest considering an even easier strategy: short selling. Technically you are borrowing the stock from someone and selling it. At some point you repurchase the stock to return to the lender ("covering your short"). If the stock price has fallen, then when you repurchase it, it will be cheaper and you keep the profit.
Short selling sounds complicated but it's actually very easy--your broker takes care of all the details. Just go to your brokerage and click "sell" or "sell short." You can use a market or limit order just like you were selling something you own. When it sells, you are done. The money gets credited to your account. At some point (after the price falls) you should repurchase it so you don't have a negative position any more, but your brokerage isn't going to hassle you for this unless you bought a lot and the stock price starts rising. There will be limits on how much you can short, depending on how much money is in your account. Some stocks (distressed and small stocks) may sometimes be hard to short, meaning your broker will charge you a kind of interest and/or may not be able to complete your transaction.
You will need a margin account (a type of brokerage account) to either use options or short sell. They are easy to come by, though.
Note that for a given amount of starting money in your account, puts can give you a much more dramatic gain if the stock price falls. But they can (and often do) expire worthless, causing you to lose all money you have spent on them. If you want to maximize how much you make, use puts. Otherwise I'd short sell.
About IPOs, it depends on what you mean. If the IPO has just completed and you want to bet that the share price will fall, either puts or short selling will work. Before an IPO you can't short sell and I doubt you would be able to buy an option either.
Foreign stocks? Depends on whether there is an ADR for them that trades on the domestic market and on the details of your brokerage account. Let me put it this way, if you can buy it, you can short sell it.
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5You should mention that there is no upper limit on your losses if the stock goes through the roof after you short it.– KevinCommented Apr 2, 2016 at 20:55
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Be sure to read the fine print on the margin account especially re margin calls. In general, the broker doesn't have to tell you if you don't have enough equity in the account and can close/partially close your position without any warning. Commented Apr 2, 2016 at 22:15
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It's absolutely false to say "If you can buy it, you can short sell it." Things that are falling become "hard-to-borrow," making a short sale for the regular investor impossible. There's also OTC and other types of stock that you won't be able to short even though you could buy.– user32479Commented Apr 4, 2016 at 0:00
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@Brick I mention the issues you raise at the end of my longest paragraph. The comment that concerns you relates to the country of origin of the stock, as I think is clear from context.– farnsyCommented Apr 4, 2016 at 0:12
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@Brick Also for future reference, be aware that OTC traded stocks can indeed be shorted. They may or may not be hard to borrow. Depends on your broker and the circumstances of the stock. Also, hard to borrow stocks frequently can be shorted by regular investors...just not as cheaply.– farnsyCommented Apr 4, 2016 at 0:17
There are three ways to do this. So far the answers posted have only mentioned two. The three ways are:
- Sell the stock short
- Buy a put option
- Create a synthetic short position
Selling short means that you borrow stock from your broker and sell it with the intent of buying it back later to repay the loan. As others have noted, this has unlimited potential losses and limited potential gains. Your profit or loss will go $1:$1 with the movement of the price of the stock.
Buying a put option gives you the right to sell the stock at a later date on a price that you choose now. You pay a premium to have this right, and if the stock moves against you, you won't exercise your option and will lose the premium. Options move non-linearly with the price of the stock, especially when the expiration is far in the future. They probably are not for a beginner, although they can be powerful if used properly.
The third option is a synthetic short position. You form this by simultaneously buying a put option and selling short a call option, both at the same strike price. This has a risk profile that is very much like the selling the stock short, but you can accomplish it entirely with stock options. Because you're both buying an selling, in theory you might even collect a small net premium when you open. You might ask why you'd do this given that you could just sell the stock short, which certainly seems simpler. One reason is that it is not always possible to sell the stock short. Recall that you have to borrow shares from your broker to sell short. When many people want to short the stock, brokers will run out of shares to loan. The stock is then said to be "hard to borrow," which effectively prevents further short selling of the stock. In this case the synthetic short is still potentially possible.
What financial instruments are there that are profitable when an underlying assets falls?
The instrument you are looking for is called an Option, specifically a Put Option.
It allows you, within the validity date, to sell ('Put') the respective shares to the option giver, at the predefined Strike Price.
For example, let's assume APPL trades currently at 100 $ per share, and you think they will go down a lot. You buy one Put Option for 100 shares (they always come for larger amounts like 100s) for a Strike Price of 90 $, and pay 5 $ for it (it would be cheap if nobody believes they will fall that much).
- APPL goes down to 70 $. You exercise you option, and get 100 times the difference between 90 $ (strike price) and 70$ (current price), which totals 2000 $. Nice gain.
- APPL does not go down far enough or not quick enough to be within your validity date. Your option is worthless (= 100% loss!)
Note the last sentence under 2. - it is rather easy and very common when trading options to make complete losses. You have been warned.
Are they available for IPOs? They could be available for IPOs, even before the IPO. However, someone has to put them out (some large bank, typically), which is some effort, and they would only do that if they expect enough interest and volume in the trade. most of the time, there will be no such options on the market.
Are they available for foreign stocks?Yes, but again only selectively - only if the stock is well known and interesting enough for a broad audience.
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1"it would be cheap if nobody believes they will fall that much" - the price for options typically follows the Black-Scholes model closely and doesn't reflect market opinion at all. Puts don't get cheaper when a given stock is favorable. Commented Apr 3, 2016 at 23:26
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Correct. I forgot that the share price already contains the market's expectations. The option price then follows more or less mathematically, as there is no additional 'information' to be priced in.– AganjuCommented Apr 4, 2016 at 1:05
Shorting Stocks: Borrowing the shares to sell now. Then buying them back when the price drops.
Risk: If you are wrong the stock can go up. And if there are a lot of people shorting the stock you can get stuck in a short squeeze. That means that so many people need to buy the stock to return the ones they borrowed that the price goes up even further and faster.
Also whoever you borrowed the stock from will often make the decision to sell for you.
Put options.
Risk: Put values don't always drop when the underlying price of the stock drops. This is because when the stock drops volatility goes up. And volatility can raise the value of an option.
And you need to check each stock for whether or not these options are available. finviz lists whether a stock is optional & shortable or not. And for shorting you also need to find a broker that owns shares that they are willing to lend out.
