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Dagon 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?
Accurate, but not asymmetrical. It's perfectly symmetrical: purchase of an asset for resale has a loss floor and no gain ceiling, sale of an asset (including short sales) has a gain floor and no loss ceiling. For actual transactions in either direction, there is a practical maximum gain/loss, even when there's not a theoretical one: if a value goes too far out of modeled range, one of the parties will abrogate when not able to pay the ludicrous amount.
For smaller investors making short-term trades (which is illegal if one has inside info, and unwise if not), generally Call or Put options are used. The constraints of payout/loss can get quite complicated fairly quickly by mixing different strike and maturity options.