Options In Focus: Putting Together a Short

Investor's Business Daily, March 7th, 2007

Is the market going to make good on day two of its rally attempt by delivering a follow-through day, perhaps as early as Friday? That's probably the million dollar question for a few well-heeled institutional types at this stage of the market's correction. On the other hand, for many limited risk strategists like me, the proverbial gray area that we're faced with currently might mean other opportunities already exist. By other opportunities, ideas such as bullish softer Delta or directionless strategies, like the ones discussed over the last few articles might come to mind.

For other traders though, and also like me, the current situation and a market still under correction, may be worthy of locating some limited risk shorting opportunities. In the following, I'd like to begin a two-part piece which covers some of the basics of shorting with options. We'll also explore some of the criteria that I use in my own directional trading when scouting out potential opportunities by offering up a current, still to be determined, real world position.

As many traders are aware, shorting the market is somewhat different and sometimes more difficult than being positioned long. Short squeezes, potential downtick rules and the fact that markets often move much faster when correcting are some of the more challenging factors presented to would-be bears. In that respect, the use of limited risk Put strategies like outright purchases, Bear Verticals or Long Condors / Butterflies can make for a more sensible approach. Gap risk courtesy of short-covering or lightening quick 'bear market rallies' can make even a well-intentioned stop, something other than an easily and manageable reality at times. It's for that type of reason alone, that at least attempting to qualify the trade with an optionable solution is a smart choice. Bottom-line, while both a short stock and the options position would likely result in losses in our accounts; at least we have an absolute ceiling on that amount with the latter.

The smart choice isn't always an option however, well, not a tradable one for our purposes. Realistically, factors such as liquidity can be an issue not so easily resolved. Something as simple as the Strikes available versus the current stock price can also make for potential headaches and enough to not merit establishing a position. At other times of course, because the stock in question might be attracting other shorts due to technical deterioration, the implieds versus the historical volatility might pose the problem of being too expensive to figure out a position that makes sense.

Remember, that with all the different types of strategies mentioned, price and time, as well as volatility, play key roles in how profitability or losses are incurred. It does us no good to enter into a strategy if a position requires realities such as a certain amount of price movement or time commitment above and beyond our tolerance levels. In those cases, even if it is a limited-risk strategy, the option isn't really a choice. For Thursday's conclusion to our two-part series, I'd like to present one current short on my own books. The idea will be, for better or worse to show readers an illustrative case study that includes the fore mentioned factors and more, that were involved in the decision-making process. And quite possibly, for better or worse, the exiting part as well.

Copyright 2007 Investor's Business Daily, Inc.

The observations provided are not investment advice or a recommendation, the suitability of which is considered the responsibility of the trader. Copyright 2006 through Optionetics, Inc. All rights reserved. Optionetics is a Trademark or a registered Trademark of Optionetics, Inc., in the United States and/or in other countries.