The idea of short selling is to profit in a declining market. As a result of the ban on short selling, whereby and investor/trader will sell stock that is either borrowed, or not yet owned, only to buy the stock back at the lower price, many have shifted to the use of options in order to achieve the same results in a declining market.
There has been no ban on the type of orders that can be placed using exchange traded options. The interest in the use of options to create short positions has increased substantially since the ban on short selling in September 2008.
Put options (whereby the holder has the right but not the obligation to sell stock at a specific price) have been used for quite some time as a hedge for holders of stock, but can also be useful for a speculator who will ultimately see the value of his or her put option rising in value as the underlying stock declines. The case being that the put holder is able to sell stock at a price higher than what the underlying market for that stock actually is.
Another way for an option trader to profit from a declining market is through the sale of a call option (whereby the holder has the right but not the obligation to buy stock at a specific price). In order to obtain this right, the buyer pays a premium to the seller of the option. If the stock does not rise past the specific price set in the terms of the options contract then the seller of the call option will keep all the premium paid by the buyer of the call option. The reason being, as a result of the stock having declined in value, it would be cheaper to buy the stock on the market then it would at the specific price set in the options contract.
When the above two strategies are combined, it is known as a synthetic short. Synthetic, as the word implies, is the use of different tools to achieve the same result that short selling seeks to achieve.
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Matt Comyn, General Manager, CommSec
Disclaimers: The views expressed in this article are those of Matt Comyn, a representative of Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814. Commonwealth Securities Limited (CommSec) ABN 60 067 254 399 AFSL 238814 is a wholly owned but non-guaranteed subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 and a Participant of the ASX Group and the Sydney Futures Exchange. As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this information, consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice. Exchange Traded Options are issued by Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814. A Product Disclosure Statements is available by calling 13 15 19 (8am-7pm Monday to Friday, EST) or by visiting commsec.com.au. You should consider the appropriate PDS before making any decisions about the products.