Put vs. short and leverage | Finance & Capital Markets | Khan Academy

Put vs. short and leverage | Finance & Capital Markets | Khan Academy


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. This one’s a little
bit more complicated, because shorting is a
little bit less intuitive. 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. And then I would
sell it for $50. But the reality is that you
do have to put some capital upfront, because the short
can move against you. And usually you have
to put at least 50% of the value of the short. So in our short scenario, you
would have to put at least $25 up front. 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. But the upfront capital is $25. 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. In the scenario where the
stock went down to $20, you made a profit of $30. You were able to buy
that stock for $20, and then give it back
to the original person. So you were able to keep that
$50, although net for that $20, so you made $30. So you made $30 on
a $25 investment. So your gain, you
make, what is that? You make $25 and then another
$5, so that’s 120% gain. So let me write that down. You had made 120% gain. Of course, in this
scenario, you gained when the stock went down. In terms of loss here,
when the stock went up, the stock went up to $80,
we lost $30 by shorting. So we had 120% loss. 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. So in the best
possible scenario, you have to put $25 up front. You can keep the $50 that you
got from borrowing and selling the stock. So you could make a
200% percent return. In the worst case scenario,
so the best scenario is this is 200%, in the worst
case, this would be infinite. So you have to be very
careful while you’re shorting. But let’s think
about the put option. In the put option, we only
have to put $5 upfront to actually buy the put. And when the stock went
down to $20, we made $15. So this was a 300% gain. 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. So the worst thing we
could do is just lose 100%. 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.

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Comments

  1. Agreed, I look forward to getting back home so I can watch these new videos. Although I have to say that since I started doing some other reading and research on our financial markets, and how they operated during the financial crisis in particular, I'm beginning to wonder if they have any real value — or at least, any value that justifies the enormous liability they can become.

    It gives this sort of info a slightly sour taste.

  2. Hey Sal, a bit of a technical comment.
    I noticed lately in your videos that your pointer is invisible. Because of this it becomes a little hard to see where you are writing, specially when the screen becomes busy with information.

  3. If the underlying stock price gets to $41, you lose 100% (the $5) with the put but earn $9 with the short.. the put looks better in this video because the price moved so much (from $20 to $80). In reality where stock price seldom go up and down so much, the short can sometimes be better.

  4. Under the Shorting scenario, your 'Gain' would be $55 and not $30, right? You also get your upfront investment of $25 back once you have returned the stock after buying back. Gain% thus being 220%.

    Other way of looking at it is, you had $75 to buy back like you mentioned in the video, then you buy back at $20 – so you should be left with $55 at the end. Hence gain % would be $55/$25*100 = 220%.

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