Outnumbered,
"Shorting" is selling something you don't own (ie, long) in the expectation of buying back at a lower price, hence a profit.
This can be done by selling a cash instrument such as stocks, bonds, commodities, fx, etc. A cheaper alternative is derivatives (futures and options) of the cash market to achieve the same or similar result.
For example, to short the FTSE you could sell all the constituent stocks in their relative weightings. However, this is expensive (commissions), relatively inefficient(?), may have tax implications if you are long the underlying constituents, eg suddenly attracting CGT if profitable, and possibly missing dividend income.
Alternatively, you could sell a FTSE future for a fraction of the cost to achieve the same exposure – 1 future contract is equivalent (roughly – carrying costs should be accounted for).
Options will also achieve a similar result but the pay-off will not be one-for-one (or point-for-point).
There are two ways to replicate shorting here: sell a call option; buy a put option. To achieve point-for-point you would need to sell a deep in-the-money call option, ie a high delta of c 0.75 plus. Your correspondence with cash here will be roughly (delta changes with a change in the underlying value), Cash x 0.75. Or you could buy a put option.
An at-the-money option will have a delta of c 0.50 to give 50% exposure; an out-of-the-money option (0.25 delta) will give 25% exposure. The lower the delta, the cheaper the option but the greater the return in percentage terms. The converse applies to a losing option position. So, in relative terms options provide greater flexibility in the amount of risk one can assume.
However, while the cash or futures move together other factors need to taken into consideration with options, and whether one is long or short – delta (as already mentioned); theta (erosion of the time value element of the premium); implied volatility (high or low) which will raise (or lower) the premiums if it rises (or falls); vega, which expresses the degree of change in the premium for a change in volatility. Some may consider Rho – the impact of interest rate changes – as another factor, but unless one is talking about massive positions I don’t think it’s that important.
That’ll be £50 please. OK, Nine can pay it – he owes me big-time.
Grant.
