Put vs. short and leverage

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Put vs. short and leverage발음듣기

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Let's think about how put options can give us leverage on a downside, or I should say, on a bet that the stock will go down relative to shorting.발음듣기

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This one's a little bit more complicated, because shorting is a little bit less intuitive.발음듣기

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But if you were to short a stock, in order to short it, you might say hey, I don't have to put any money up front, because I essentially just borrowed the stock immediately.발음듣기

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And then I would sell it for $50.발음듣기

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But the reality is that you do have to put some capital upfront, because the short can move against you.발음듣기

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And usually you have to put at least 50% of the value of the short.발음듣기

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So in our short scenario, you would have to put at least $25 up front.발음듣기

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And then you would borrow the stock, sell it for $50, and so you'd essentially have $75 to play with that you would eventually have to use to buy back the stock.발음듣기

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But the upfront capital is $25.발음듣기

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Now, in our scenario where the stock went down, which was a good thing if you're shorting, you want the stock, that was your bet, you want it to go down.발음듣기

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In the scenario where the stock went down to $20, you made a profit of $30.발음듣기

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You were able to buy that stock for $20, and then give it back to the original person.발음듣기

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So you were able to keep that $50, although net for that $20, so you made $30.발음듣기

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So you made $30 on a $25 investment.발음듣기

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So your gain, you make, what is that?발음듣기

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You make $25 and then another $5, so that's 120% gain.발음듣기

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So let me write that down.발음듣기

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You had made 120% gain.발음듣기

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Of course, in this scenario, you gained when the stock went down.발음듣기

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In terms of loss here, when the stock went up, the stock went up to $80, we lost $30 by shorting.발음듣기

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So we had 120% loss.발음듣기

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And it's important to realize, in a short situation, the best thing that could happen for you, is your stock go to zero, in which case you can buy it back for nothing, which means you could keep your $50.발음듣기

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So in the best possible scenario, you have to put $25 up front.발음듣기

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You can keep the $50 that you got from borrowing and selling the stock.발음듣기

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So you could make a 200% percent return.발음듣기

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In the worst case scenario, so the best scenario is this is 200%, in the worst case, this would be infinite.발음듣기

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So you have to be very careful while you're shorting.발음듣기

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But let's think about the put option.발음듣기

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In the put option, we only have to put $5 upfront to actually buy the put.발음듣기

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And when the stock went down to $20, we made $15.발음듣기

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So this was a 300% gain.발음듣기

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And on the other side of the equation, when the stock went up, the worst we could do is just lose all of our money.발음듣기

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So the worst thing we could do is just lose 100%.발음듣기

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So once again, we were able to multiply our gains relative to shorting, although it's a little bit more mixed on the downside, because the put gives you a little bit of protection there.발음듣기

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