Using Options to Short the Market without Margin Calls

What if you could bet against the market, without risking a margin call?

In traditional short-selling scenarios, traders and investors run the risk of forced liquidations, margin requirements, and the prospect of unlimited risk, in some cases. It can create a lot of mental fatigue and pain for traders, but the great news is that there’s a way you can short the market, and margin calls aren’t even a factor!

Our guide will focus on this smarter, safer way to profit from falling prices—without the headaches of margin. It involves using options to short the market, putting the trader in a place where they aren’t running the risk of a margin call. We will cover specific option strategies, risks, and step-by-step how-tos to give you a deeper understanding of how you can incorporate this move into your trading plan.

Why Margin Calls Are a Short Seller’s Nightmare

To be clear on why margin calls are a nightmare for short sellers, let’s outline exactly what the short-selling strategy is, in case you don’t know. Consider these the short-selling basics: how it works and why traders are drawn to this strategy.

Short Selling Explained

Short selling is a strategy in options trading and investing where the trader borrows shares of a stock and then sells them right away. They do this with the hope of repurchasing them at a lower price later and then securing a profit from the difference.

Margin calls present the potential for unlimited losses to the short seller, and there are scenarios where they could force a trader to liquidate to meet their obligations. A few other downsides that short sellers might experience are forced selling at a loss, as well as a phenomenon known as the “short squeeze effect.”

The Dangers

Now that you know why margin calls are a short seller’s worst nightmare, let’s talk specifically about some of the primary dangers that traders are up against with margin calls.

• Margin Requirements—This is the percentage of a trader’s value that has to be covered by the trader’s own funds. Failure for a short seller to meet a margin call within the timeframe gives the broker the right to liquidate the short position, and this could happen at an unfavorable price.
• Margin Calls During Volatile Moves—Rising stock prices can lead to waning account equity, and it could trigger margin calls. These can force short sellers to buy back shares, and this results in the stock price going higher and leading to more margin calls. The big danger here is that volatile markets can create a feedback loop for short sellers.
• Unlimited Loss Potential—When sellers short their stock, they’re borrowing shares and selling them, anticipating that the price is going to fall. It allows traders to buy back the shares later at a lower price and return them to the lender. The main danger here is that the stock price can continue to go up, and the short seller is forced to buy back the shares at a higher price to return them.
• Forced Buy-Ins at the Worst Time—This danger can occur a lot of time during a short squeeze. If the owner of the shares decides to sell them, they can demand to get them back from the short seller, which would force them to purchase them back (a forced buy-in). The short squeeze is when short sellers have to buy back shares all at once when a sudden price increase occurs.

The Stress Factor

Many traders cannot handle the stress that comes from short selling, and that makes them avoid the practice altogether. There are a lot of factors driving this, including the following:

• Borrowing money from the broker to trade on margin adds to the overall cost of the trade.
• Brokers could issue a margin call, where you’re required to deposit more funds into your account to meet minimum equity requirements.
• Short sellers might be forced to buy additional shares to cover their positions, which can drive the price up even further—this phenomenon is known as the “short squeeze.”
• The process of short selling requires precise timing, which can be challenging for traders. Significant losses could accrue if you enter too late or too early.

How Options Can Solve the Margin Problem

Traders using certain options strategies, like buying puts, can bet against the stocks or the market without having to borrow shares in the process. Using options when shorting the market creates a situation where the trader doesn’t have to deal with margin calls. Option buyers can enjoy limited risk, and they are never in a scenario where they would even owe more than their original investment.

You can use a wide range of options strategies to short the market and avoid margin calls, including the following paths:

• Using Options Compared to Stocks: Options provide traders with a lower capital commitment using strategies like ITM calls and synthetic long stock positions. In many cases, these strategies can simulate the exposure of owning the underlying stock, but it comes at a much lower price than buying the stock outright.
• Better Control of Leverage: Another perk of using options for shorting the market is that they provide more control for the trader when it comes to leverage. They can avoid margin calls altogether by being able to tailor their risk exposure more competitively and control leverage more precisely compared to buying stocks on margin.
• Options Hedging: Even if you buy stocks on margin, there are ways you can use options to prevent margin calls from occurring. Buying put options on stocks that were bought on margin can work like an insurance policy.
• Short Positions Incur Limited Losses: Buying call options can put a limit on potential losses if you’ve shorted a stock on margin, and this can come in handy if the price of the stock goes up considerably. Using options can create a situation where the trader can keep themselves safe from margin calls that arise from losses incurred from a short position.

A Comparison of Collateral and Risk

When you’re looking at the key differences between shorting stock and buying puts, you’ll see that there are some differences between the collateral associated with and the risk taken on with each approach.

Shorting Stocks

This approach requires the trader to have a margin account where they are required to maintain an initial margin as collateral (it is using 50% or more of the position’s value). When it comes to risk, shorting stocks technically has unlimited risk because there is technically no limit to how high the stock price could go. Short sellers run a considerable risk of losing more money than the money they initially put down for the trade if the stock price goes up significantly.

Buying Puts

Unlike shorting stocks, where traders have to retain a margin account, buying puts only requires the trader to pay for the premium upfront to enter the trade. It is a much more accessible form of trading as there is no borrowing involved and no collateral requirements whatsoever. The only loss associated with buying puts to short the market is the premium (the amount paid to enter the trade), and this occurs if the stock price rises or stays above the strike price by the expiration date.

Strategy 1—Buying Puts (The Direct Short Alternative)

A put option refers to a contract that gives the put buyer the right to sell the underlying asset at a strike price on or before the expiration date of the contract. The buyer has the right to sell, but they are by no means obligated to do so. To gain this right, the buyer pays a price to the seller, which is known as the “premium.” Buying puts is a strategy that is broadly used by options traders as a form of insurance or to profit from the price decline of the asset being traded.

Simple Example

Buying a put on SPY or a single stock is a good way to illustrate the idea of buying puts. Whether you’re trading options on the S&P 500 or dealing with a solitary stock, you’re placing a bet on the decline of the stock, ETF, or other asset because put options are profitable for traders when the underlying goes down in value.

Step-by-Step

If you aren’t sure how buying puts works, we have included this guide for your convenience. Read the step-by-step instructions below to get started.

1. Pick your target stock/index. It is key to look for assets that have higher trading volumes and narrow bid-ask spreads (more liquidity) for the best possible execution.
2. Choose expiration and strike. Select an expiration date that aligns with your current market outlook and trading strategy. Choose a strike price that is below the current market price.
3. Buy the put—define your risk upfront. You believe that the asset you’re dealing with will decline in value. Your losses are limited to the premium paid to enter the trade. Keep an eye on volatility levels that could drive the premium up—you want to enter the position when volatility is lower.
4. Look into the potential profit and loss scenarios. Profit is calculated by subtracting the premium paid for the put from the difference between the strike price and the underlying asset’s price at the expiration date. The max loss is limited to the premium paid to enter the put contract, as we mentioned before.

Benefits

• Limited Risk—The biggest risk with buying calls is limited to the premium paid to enter the trade.
• No Margin Call—When you’re dealing with buying stocks outright, you have to maintain a margin account, and margin calls can happen. However, using options strategies like buying puts can lower capital commitment, and there are no margins to maintain or margin calls that arise.
• No Borrow Fees—Buying puts doesn’t require traders to borrow money to trade. You buy the premium to attain the right to sell the underlying at a certain strike by the expiration date.
• Leverage—Buying puts lets traders manage a relatively large position for a smaller capital commitment compared to buying the stock outright.
• Making Money on Market Declines—Buying puts offers a nice level of flexibility for traders who are looking to make money on stocks or assets that are on the decline. Even when the future of certain investments looks bleak, traders can buy puts on these positions to speculate and generate profit on their decline.

Downsides

• Time Decay (Theta)—Because options contracts have a limited timespan, the value of put options goes down as the expiration date draws closer. Theta decay even presents a threat even if the underlying stock price doesn’t move all that much.
• Upfront Premium—Traders have to pay a premium to enter the trade, and this represents the maximum loss potential for the strategy. It is a smaller capital commitment compared to buying the stock outright, but trading puts does have an upfront capital commitment, which is to be expected.

Strategy 2—Bear Put Spreads (Short the Market for Less)

This option strategy that traders tend to use when they’re expecting a moderate decline in the underlying asset’s price. The setup of the bear put spread is centered around two put options with the same expiration date. The trader buys one put option with a higher strike price and then sells another with a lower strike price.

The premium the trader pays is known as a “net debit” because the first put they buy has a higher premium than the premium they get from selling the other put option. The net debit also represents the maximum loss, and this occurs when the asset price is above the higher strike price on or before the expiration date.

The max profit associated with the bear put spread is the difference between the two strike prices, but you also have to subtract the net debit. Profit is limited compared to other strategies, and the bear put spread works when the asset price falls below the lower strike price on or before the expiration date.

How to Set Up the Bear Put Spread

Let’s go through the process of setting up the bear put spread. This little step-by-step guide can be handy for anyone who is putting together this strategy for the first time. Follow these instructions to get set up!

1. Buy a put at a higher strike. This represents the first half of the spread.
2. Sell a put at a lower strike, but with the same expiry. You can figure out the max profit by taking the difference between the two strike prices, minus the premium.
3. The bear spread a few outcomes where there is limited profit potential, but also a limited loss level. When you compare this spread to buying a naked put, you can see why it is the preferable course of action. Buying naked puts comes with a limited profit potential, but also unlimited risk if the stock price drops considerably.

Example Trade

What are the possible outcomes associated with the bear put spread? We have included them below in an example trade scenario to give you a true idea of what could come from using this strategy.

• Risk and Reward: The maximum loss is limited to the net premium, which renders both put options worthless if the asset price is above the higher strike price by the time of the contract’s expiration.
• Max Gain (Profit): It is the difference between the two strike prices of the spread, minus the premium.
• Capped Risk: The risk associated with the bear put spread is the net premium paid for the trades (the spread’s cost), and the best part of all is that there are no margin calls involved.

Strategy 3—Inverse ETFs and Put Options

Using options contracts on inverse ETFs can help traders improve their short exposure. Trading options on these tickers can boost leverage while still avoiding margin calls. A few good examples of these inverse ETFs include the following:

Examples

• SPXU—ProShares UltraPro Short S&P 500
• SQQQ—ProShares UltraPro Short QQQ
• SH—Short S&P 500

There are some caveats that traders should keep in mind when combining options trading with inverse ETFs, including decay and compounding risk in leveraged/inverse ETFs.

Risks and What to Watch Out For

What are some of the risks and challenges you come up against when you’re using options to short the market without margin calls? We have highlighted them in this section to give you a good understanding of the risks associated with this workaround. Perhaps the most important thing to keep in mind is that options are not risk-free. A lot of the risks we discuss here have to do with the nature of options contracts in general.

• Time Decay—The value of the option goes down as the expiration date gets closer. Time decay is still going to happen even if the underlying asset’s price stays the same. To profit from a short-selling move like a long put option, you need the market to move in the desired direction quickly for a profit to be secured.
• Volatility Crush—This risk arises when there’s a quick, significant decrease in an option’s implied volatility that usually happens after a major market event like a corporate news release, an earnings announcement, or an economic data release.
• Expiry Risk—When you’re using strategies like selling put options or bear call spreads, traders must be careful about managing their position to get it to be profitable before the option contract’s expiration date sets in.
• Overpaying for Puts in High-Volatility Markets—Traders could make the grave mistake of buying put options in high-volatility environments and overpay due to the premiums being higher than usual, thanks to the higher level of volatility. It is best to use options to short the market when volatility levels are lower.

When it comes to using options to short the market, the maximum loss is always limited to the premium (or spread cost), but position sizing and timing still matter.

When to Use These Strategies (Best Use Cases)

When is it best to use options contracts to short the market without margin calls? We have outlined the best use cases below to show you when using this trading strategy is ideal. If you’re dealing with scenarios that are outside of these best use cases, it might be better to use a different approach.

• Hedging an Existing Portfolio—Traders can use strategies like buying protective puts or using a collar strategy to limit potential loss by providing the right to sell at a certain price or by creating a range where the value of the portfolio is protected.
• Speculating on Market Corrections—Buying put options can be used to speculate on stocks or indices when a trader is expecting the market to decline. Put options increase in value when the asset price falls below the strike price of the contract before the expiration date occurs.
• Trading During Earnings Season or High Volatility—Using options for shorting the market during periods of higher market volatility can be ideal due to the opportunities that come up for bearish and bullish traders alike. They can be especially useful for periods like earnings season, where market volatility tends to uptick.
• Swing Trading in Downtrends Without Tying Up Lots of Capital—Options offer an alternative for traders to short the market with a smaller amount of capital (compared to buying stocks outright), and it can work to great effect in downtrends for swing traders.

Step-by-Step—Placing a Put Trade in Your Broker Account

If you’re wondering how you go about placing a put trade with the brokerage app or website of your choice, you can follow this general guide for getting started and hitting the ground running. Upfront, we would like to give you a solid tip before you jump in: use the broker’s “max loss” calculator for peace of mind.

1. Search for the underlying ticker.
2. Go to the options chain.
3. Select the desired strike/expiry.
4. Enter a buy-to-open order for a put or spread.
5. Review risk—confirm no margin requirement.

Why Smart Traders Use Options to Bet Against the Market

Using options in shorting the market allows traders to avoid the pain of margin calls. We consider it the safe and smarter way to short, so we’d encourage you to learn as much as you can to begin using options instead of buying stocks outright to short the market. Use puts options to bet against the market, and you can avoid margin calls and margin requirements entirely! Put options come with limited profit and loss scenarios, but you’ll never be exposed to a debilitating loss like you would with trading on margin and buying stocks outright.

Key Takeaways

• Options let you bet against stocks/markets with limited risk and no margin calls.
• Buying puts or put spreads can replace traditional short selling.
• No risk of forced liquidation or unlimited loss.
• Upfront premium is your only risk—position sizing is key.
• Practice in a demo account if you’re new.

Frequently Asked Questions

Check out the most common questions we have gotten from our readers and customers about options trading and how it can be used to short the market without the possibility of margin calls.

Can You Short the Market without Using Options?

Yes, you can short the market by trading on margin and buying stocks outright, but you run the risk of having to maintain a margin account and possibly being subject to margin calls where you face forced liquidations to meet financial commitments. The appeal of options is that you can short the market (at the cost of an upfront premium), but you aren’t dealing with a margin account and the obligations that come with that.

Are There Any Margin Requirements for Buying Options?

No, there aren’t any margin requirements. Buying options involved paying a premium, which serves as the maximum loss for the trade. The big appeal of using options to short the market is that there aren’t any margin requirements to maintain.

What Happens if My Put Expires Worthless?

Put options expire worthless if the price of the underlying remains above the strike price of the put option until the expiration date. When this happens, the option holder loses the premium they paid to enter the trade, but the option seller gets to keep the premium. After the put expires worthless, the contract becomes void and disappears from the trading account.

What’s Better for Beginners—Buying Puts or Spreads?

Spreads come with some significant risk-reduction features, and this makes them the preferred options for beginners who are trying to figure out if buying puts or spreads is best. Using spreads comes with a lower form of the initial cost of the spread as opposed to the entire premium associated with buying puts alone.