When you’re short a stock you’re completely exposed if the stock’s share price begins to rise. With a long position, your downside risk is limited to the value of the purchase but, when you’re short, the stock price could theoretically rise to infinity so your risk in being short is, again theoretically, infinite.

Due to this risk, short sellers often buy call options as a form of insurance against the downside risk of being short a stock.

For example, suppose you’re short 100 shares of Google (GOOG) stock which you sold at $550. Turns out you’re completely wrong about how overvalued the stock is and it subsequently rises to $600. You can either admit your mistake and buy at $600 to close your position and lock in that $5,000 loss or hold on hoping that GOOG will eventually fall far enough for your position to become profitable but not rise far enough that your losses will accumulate to more than you can afford or, in a worst case scenario, to more than you sold the stock for in the first place.

If you had also bought a call option on GOOG when you went short you would have protected yourself from catastrophic losses. By buying a call option with a strike price of $600 you would have limited yourself to a maximum loss of $5,000 for the length of that contract. It’s not a great thought to be out $5,000 but the $1,000 or so in premium you would have paid for the call option acts as insurance that you won’t end up being out much more.

And, when you compare $1,000 against the $55,000 you risked to take the short position, your call option insurance plan only cost you about a 1.8% premium. Not a bad trade off when you consider it could very well protect you from thousands of dollars in losses should your opinion of Google’s future prospects be completely wrong.

This also illustrates one of the traits of successful traders which is the ability to limit losses. Trading is risky but, if you’re smart and use strategies like call options to limit the maximum possible amount you’ll lose on any given trade, those risks can be calculated and effectively managed. It’s only when downside risk isn’t planned for and accounted for that trading becomes unbearably risky and starts to look more like pure gambling.