You can protect your upside with calls.
Buy an out of the money call.
Say you short XYZ at 100, but you want to limit your potential loss on the upside to 10, buy a 110 call. A front month (expires within a month) call, 10% out of the money, will cost you 3 or 4 percent for a somewhat volatile stock. An at the money, 100 strike call will cost you 8-10 percent, more if the stock is very volatile. It will also cost more if you want "protection" for more than a month.
Protection isn't cheap. When do you sell the call, betting that the stock really isn't going to go any higher? If you hold till expiration, you lose all the time value (your entire cost for the call since it was out of the money), plus the 10% rise (if the stock went up), if the stock takes the hoped for dive, all is well, you are just out your insurance premium.
You're probably better off just setting a mental stop, or just hanging on if you are sure about your facts on the lack of value of the underlying.
Another approach is to buy puts instead of shorting. This limits your loss to the cost of the put. You face the same decisions about time, the more time you want, the more it costs. You can buy an in the money put, in the case of XYZ at 100, you can buy a 110 or 120 put (already in the money by 10, or 20 bucks). You pay less time premium in this case.
Finally, you can sell a call, to pay for your put (this is equivalent to shorting), your upside loss is not limited since the call you sold will continue to go against you as the stock rises. Consider this only if you can't short the stock (not available to borrow). Your transaction cost is a little higher than shorting since you pay two commissions and two spreads.
-George |
