3 Ways to Sell Short

(by Michael Shulman)

Investors can short three things: an individual company, a market segment, or the market itself.

  • A Company: Most people associate shorting with companies, and there is a tremendous and growing volume in short positions in many firms. To be successful, an investor must look at the liquidity of the stock or the put contracts associated with that stock, not just the fundamentals of a company. If a mid-cap stock has a small float (shares outstanding and available) and very few put contracts are traded every day, it will be difficult, perhaps impossible, to short the stock. And when you want to exit, it may not be possible at a fair price if there is too little liquidity in the stock.

  • A Market Segment: You may know that you can use indexes, Exchange-Traded Funds and other instruments to go long a sector, such as buying the Energy Select Sector SPDR (XLF) if you want to go long oil. The opposite is also true -- if you think oil, semiconductors, biotech or whatever is about to swoon, you can buy puts on these sectors. For example, if you think corporate software purchasing is going to slow down and want to short the software industry, you can buy puts on the SWH, the Software HOLDRs Trust.
  • The Market: Many indices and tradable instruments can be shorted if you see the market going down, with puts on the S&P 500 and the Nasdaq arguably the most-popular instruments for individual investors. This is a simple process -- you simply buy a put on any one of a number of indices with an expiration date that fits your view of the market. A good example of this are SPDR calls and puts -- contracts on baskets of stocks mirroring the S&P 500.