Short sales and put options are two bearish investment methodologies. The concept of a bearish position can be summarized by saying that the investor will go into profit the moment the price of the security on which he is positioned falls.
Difference between Short Selling and Put Options
Although both Short Selling and Put Options are two bearish investment strategies, in the case of Short Selling the investor will sell a security that he or she does not own, since it was borrowed and then put up for sale in the market to be repurchased later. In the case of buying a Put Option, on the other hand, one has the right to sell a financial security at the price indicated by the option, with a maximum loss equal to the premium paid for the option.
Both methods relate to the bear market and are not recommended for anyone new to the world of investing, where it is usually safer to operate through bullish positions.
Let's take an example with Coca Cola. I have a forecast of a drop in the stock price. I can either sell short the stock at $40 (with all the benefits and risks we explained earlier) or buy a monthly put option on 100 Coca Cola shares paying a premium.
Assuming a premium of $1, the total premium paid will be $100 (remember that each option moves 100 shares so the option premium is to be multiplied by 100) expiring one month. If Coca Cola shares after one month price at $30, our gain will be $9 per share or $900, resulting from selling the shares at $40 (thanks to our put option) that price $30, minus the premium paid of $1 (($40-$30)-1$) *100.
What if Coca Cola stock had gone up what would have happened? The option would have expired worthless and the loss would have been limited to $100.
In the case of Short Selling, although the gains if the stock falls may be greater, any losses are unlimited because the price of a stock can continue to rise without a well-defined limit.
In essence, trading through Short Selling represents a riskier and more profitable approach, while using Put Options allows losses to be limited to a price equivalent to the premium paid.