Buying puts, for me, is hands down a much better strategy on individual stocks. Shorting exchange traded funds is probably better stategy than buying puts for "short basket plays" when you just want to bet on a general down overall market.
I like to buy puts that expire 6-12 months out and that are kinda deep in the money. For example, I'm currently considering buying puts on BSC (Bear Stearns). BSC is currently trading at 109.60 per share. If I wanted to short the stock outright (1k shares) I would have to have 55,000$ in my account and I would automatically be on margin and paying interest every month because I'm borrowing money from my broker. For my example lets say that all I have is 55k in my account and thats what I want to do. My broker must have the shares for me to "borrow" them to sell them short or the trade will be rejected, but that rarely happens on stocks that trade more than 500k shares per day. I will also have to pay 32c per share in divedends every quarter that I'm short when dividend day rolls around for BSC. If the trade goes against me and BSC were to rise 25% or more I'm going to get a margin call for 30,000$ and if I don't deposit the money, then my broker is going to buy back the shares on my behalf and I will have lost around 30k but I will still have about 25k left to reshort with, but I'm only going to be able to short around 300 shares and will need a huge move just to get back to even. One last nightmare that can happen when shorting stocks and it's a doozie is that the stock can be bought out overnight and it could cause lots of heartache. Lets say in my example that BSC was bought out for 200 bucks a share overnight while I'm short 1,000 shares at 110 bucks per share. Well now I'm completley wiped out. The equity in my account would be a negative of over 45,000$. This means I must pay my broker 45k and if I don't, they are going to take me to court to get their money. Buyouts like this rarely happen but look at AQNT this year and it does happen. In fact there was a report released this weekend that BSC could double on a buyout this year but I don't think that will happen.
To avoid all of those headaches here is what I would do instead. I would simply buy 10 Jan 08 130 puts for 25,400$. I would be paying 6.6 points of "premium" to limit my risk and sleep at night but I would still control 1k shares to the short side. So in my example lets say BSC rallies to 130 by this time next month and is sitting at 130 bucks per share, my puts would still be worth 10k yet I was wrong on the trade by 20 points.
If you can understand all of the mumbo jumbo I've written here then you should be able to see that puts are much safer than shorting but you do have to pay a small premium for the "protection".
Any questions let me know
Ps. I do think BSC will drop to 90 bucks per share sometime within the next 12 months and If I decide to put a trade on, I will do just what I explained in this example.
