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D_Malik comments on Stupid Questions, December 2015 - Less Wrong Discussion
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Repeating my question from late in the previous thread:
It seems to me that if you buy a stock, you could come out arbitrarily well-off, but your losses are limited to the amount you put in. But if you short, your payoffs are limited to the current price, and your losses could be arbitrarily big, until you run out of money.
Is this accurate? If so, it feels like an important asymmetry that I haven't absorbed from the "stock markets 101" type things that I've occasionally read. What effects does it have on markets, if any? (Running my mouth off, I'd speculate that it makes people less inclined to bet on a bubble popping, which in turn would prolong bubbles.) Are there symmetrical ways to bet a stock will rise/fall?
You usually avoid unlimited liability by placing a stop order to cover your position as soon as the price goes sufficiently high. Or for instance you can bound your losses by including a term in the contract which says that instead of giving back the stock you borrowed and sold, you can pay a certain price.
Note that for volatile assets (the very ones where you feel uncomfortable about unbounded risk), stop orders are not guaranteed to help. Remember, prices are not continuous - there is a discrete sequence of bids. Price can go from below your stop to MASSIVELY above it before your stop order can be executed. Most often this happens on news when a market is closed, but it can occur intraday as well.
The stop order feels hackish, to me. I was thinking along the lines of short squeezes even before I learned their name. But also, if I'm expecting a bubble to burst, I won't necessarily be surprised if the price rises massively before it does. I'd be looking for limited exposure without having to chicken out.
The contract term sounds like the sort of thing I was looking for.
You can always play with options to construct whatever payoff structure you desire.