You are allowed to be bearish at times, but it’s better to sell calls or buy anticorrelated bonds and continue to collect the risk premium, than to short the stocks and be on the hook for the dividends or buyouts.
Doesn’t “sell calls” mean the same thing as “short the stocks”?
No, it really doesn’t. You can make money from an out-of-the-money short call even if the stock goes up, as long as it stays below your strike price. You can even make money if it exceeds your strike price and then falls back below before expiration (assuming you don’t get assigned early, which can happen if there’s a dividend that exceeds the time value of the option). And even if it expires a little above your strike, if you took in enough premium, you could still come out ahead on net after subtracting your loss from covering your assigned short position. You don’t have to be right about the market direction to make money. It’s enough to not be terribly wrong.
My main point here was that you collect the risk premium for selling the call, but you pay the premium for shorting the stock.
Right. A call is an option contract. It’s a different instrument than the underlying shares of stock. You can be short a call option and not short shares. You’re still executing a bearish play on the stock, but you’re not shorting the stock.
If you get assigned on your call (unless it’s cash-settled), you will have to produce the shares to give to the contract holder. If you didn’t already have the shares, you will end up with a short position in the stock, which you will eventually have to cover by buying stock.
You can construct a synthetic short stock position using options, by selling a call, but you also have to buy a put at the same strike and expiry. This will behave very similarly to (typically) 100 short shares.
Doesn’t “sell calls” mean the same thing as “short the stocks”?
No, it really doesn’t. You can make money from an out-of-the-money short call even if the stock goes up, as long as it stays below your strike price. You can even make money if it exceeds your strike price and then falls back below before expiration (assuming you don’t get assigned early, which can happen if there’s a dividend that exceeds the time value of the option). And even if it expires a little above your strike, if you took in enough premium, you could still come out ahead on net after subtracting your loss from covering your assigned short position. You don’t have to be right about the market direction to make money. It’s enough to not be terribly wrong.
My main point here was that you collect the risk premium for selling the call, but you pay the premium for shorting the stock.
Oh so in this case you’re selling a call, but you can’t be said to be “shorting the stock” because you still benefit from a higher price?
Right. A call is an option contract. It’s a different instrument than the underlying shares of stock. You can be short a call option and not short shares. You’re still executing a bearish play on the stock, but you’re not shorting the stock.
If you get assigned on your call (unless it’s cash-settled), you will have to produce the shares to give to the contract holder. If you didn’t already have the shares, you will end up with a short position in the stock, which you will eventually have to cover by buying stock.
You can construct a synthetic short stock position using options, by selling a call, but you also have to buy a put at the same strike and expiry. This will behave very similarly to (typically) 100 short shares.