In order to short stocks, you need a margin account and a broker who’s willing to lend you shares to short. Since shorting requires borrowing shares, there are costs involved with betting against stocks this way. And if you don’t have a margin account, you won’t be able to borrow any shares to short, anyway.
However, there’s another way to bet against stocks that doesn’t involve borrowing shares but involves the use of leverage. A put option is a bearish bet against a stock, a derivative contract that goes up in value when the underlying stock declines. But as we’ve seen over the last few months of meme stock mania, betting against stocks can be a risky venture.
One of the benefits of buying puts instead of shorting shares is that your losses are limited to the amount of capital you put in. If you buy $1,000 worth of put options on Tesla (NSDQ: TSLA) and the stock shoots up 10%, the most you can lose is your original $1,000. If you shorted Tesla, your losses are uncapped and theoretically unlimited. Buying put options on Robinhood is a simple process if you follow these steps.
How to Buy Puts on Robinhood
- Find stocks you think will decline in value.
Puts are bearish bets on stocks. When you buy a put, you’re buying a derivative that gives you the choice of purchasing shares at a certain price or better before the expiration of the contract.
Put options have two parties: the writer and the buyer. The option writer sells the contract to the buyer for a premium and takes on the risk of the contract being executed. The buyer of the put option hopes to see the underlying stock decline so the put options appreciate in value. Options can be bought and sold on the open market or executed if the strike price is reached. Each put option entitles the buyer to 100 shares, but you must have enough cash on hand to purchase the stock.
One of the most famous types of put option trades is the “portfolio insurance put,” an out-of-the-money (OTM) options strategy for protecting your capital against a bearish event (or Black Swan). Long-dated OTM puts are bought to control large positions for minimal capital. The premium for the puts is like the premium for health insurance, paid in hopes that you never really have to use it.
If you want short-term success with puts, you’ll need to find stocks that form topping patterns, hitting resistance, or have a potential headwind like accounting issues or poor drug trial data. Find stocks that suit your trading style and locate them on Robinhood.
- Make sure put options are available (and liquid).
Not all stocks have options written for them. Low-priced and thinly-traded shares often have no market for options, so the only way to bet against them is by shorting. One of the unfortunate twists of buying puts is that the most liquid and available shares are usually strong and successful companies. Buying puts on long-term winners like Amazon or Microsoft is a stressful way to trade.
The best stocks to buy puts on will have lots of volume and open interest (OI). Open interest refers to the amount of contracts on the market at an individual strike and expiration date. If you see a number like 13,728 under OI on your brokerage app, that means over 13,728 contracts have been written. Volume is the number of times those contracts have changed hands. Options markets with high OI are the most liquid and easiest to trade, so keep an eye on these numbers when buying puts.
- Pick a strike price and expiration date.
The strike price is the price the underlying stock needs to reach before the contract can be executed. If you buy a TSLA put option with a $600 strike price, you’ll need the shares to reach $600 to execute the contract (add the price of the premium to find the breakeven point).
Choosing a strike price might seem easy enough, but you can’t hold options forever. You’ll need to choose an expiration date as well, a point in the future where the contract will expire worthless if the strike price isn’t reached. The further out you place your expiration date, the more you’ll pay in premiums for the puts.
As an example, let’s choose TSLA for our trade and pick the $600 mark as our strike price. Since the shares are trading around $700 today, we’ll want to pick an expiration out a few weeks. The $600 TSLA puts expiring 4/23 are trading at $24, which means it will cost $2,400 (plus spreads) to purchase a contract. Robinhood has commission-free options trading, so clients only pay the spreads.
- Decide how much capital to spend on the trade.
Options trading is risky, especially if you’re betting to the downside. Our hypothetical options trade will cost $2,400 to open one contract, so figure out how much of your portfolio you want to contribute to such a trade.
It’s important to remember that if the stock appreciates in value and your strike price is never reached, the trade will lose all value as the contracts expire worthless. You can sell the contract before expiration if the trade moves against you, but options are volatile and often lose 20% to 30% in a single session.
- Execute your options trade.
Options trade on exchanges just like stocks, just not ones as liquid or accommodating. You can use limit orders instead of market orders though, so be sure to find your ideal entry point and use a limit order to get as close to your price as possible.
Once you’ve executed your trade, your options will appear in your brokerage account. Options are volatile and risky, so be sure to keep tabs on your trade and stick with your trading plan. If your plan is to take profits at 80%, sell the contract when you’ve gained 80% — don’t deviate from the plan due to greed.
If you choose to exercise the option and purchase the underlying shares at the discounted strike price, you’ll need to follow the steps on Robinhood’s option exercising process. You can learn more about how to exercise your options and receive shares here.
|ADD||Color Star Tech||$1.03||-31.75%||$89.9K||Buy/Sell|
|ACAQ||Athena Consumer Acq||$7.48||-21.76%||$14.2K||Buy/Sell|
|RANI||Rani Therapeutics Hldgs||$2.20||-17.14%||$40.1K||Buy/Sell|
|CTHR||Charles & Colvard||$0.57||-17.02%||$86K||Buy/Sell|
|KXIN||Kaixin Auto Hldgs||$1.68||-16.84%||$80.3K||Buy/Sell|
|GBNY||Generations Bancorp NY||$8.46||-16.24%||$2.4K||Buy/Sell|
Robinhood is no longer the only game in town as the competition among commission-free brokers has become fierce. If Robinhood’s platform or policies aren’t suitable for you, consider some alternatives from our list here.
Understand the Risks Before Trading puts on Robinhood
Options are derivatives based on the value of underlying stocks. When you buy a put option, you’re buying an investment that will go up in value if the underlying stock declines. But options are difficult to trade due to volatility and complexity. Calculating the price of an option involves a detailed mathematical formula involving several factors, such as the rate of the stock’s decline and the amount of time left until expiration.
Know what you’re buying and how it operates, otherwise, your options trading career will be a quick and unsuccessful one.