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Example: Profits Becoming Unlikely: You recently bought a put for 4. However, expiration date is coming up soon and the stock’s market value has risen above striking price. When the put expires, you face the prospect of losing the entire $400 premium. Time has worked against you. Knowing that the stock’s market value might eventually fall below striking price, but not necessarily before expiration, you realize it is unlikely that you will be able to earn a profit.
Risks are lower for puts in comparison to short selling. A short seller in a loss position is required to pay the difference between short-sold price and current market value if the stock has risen in value, not to mention the interest cost. The limited risk of buying puts is a considerable advantage.
Example: Big Problems or Small: You sold short 200 shares of stock with market value of $45 per share; you were required to borrow $9,000 worth of stock, put up a portion as collateral, and pay interest to the brokerage company. The stock later rose to $52 per share and you sold. Your loss on the stock was $ 1,400 plus interest expense. If you had bought puts instead, the maximum loss would have been limited to the premium paid for the two puts. The fear of further stock price increases that would concern you as a short seller would be a minimal problem for you as a put buyer.
The advantage enjoyed by the put buyer typifies the long position over the short position. Losses are invariably limited in this situation. Although both strategies have the identical goal, risks make the long and short positions much different.