Question

You sold short 100 shares of Apple stock at a price of $140 per share. What is the worst that can happen to you and how can you protect yourself?

Answer 1

Short selling shares means you don't own the shares now. you borrow it from a dealer or broker and sell it. later you purchase those shares from the market and return it to the lender.

the short selling is done when you expect the share prices will go down. so you short sell shares at higher rates and buy it later at lower rates from the market and return it to the lender.

the worst that can happen is that share prices increase in the market more than $140 per share instead of decreasing. this increase can go to any price depending on the time period. so now you have to purchase shares at higher rates than rate at which you short sold the shares and return it to the lender. thereby incurring losses.

You can protect yourself by purchasing a call option on Apple stock. call option is not an obligation but a right to purchase share at option maturity date at option's strike price. this way you have fixed a price at which you can buy the shares. as this is a right and not a obligation, so if at maturity date market share price is lower than option strike price then you can not exercise the option and purchase shares at strike price. you will let the option expire worthless.

for this this right to purchase at strike price, you have to pay a premium upfront to purchase the option.