Something about selling short has always bothered me. My brother has been a broker for 20 years and whenever he talks to me about this concept I shake my head.
I read (no cite, sorry) that supposedly BinLaden and/or cronies sold short lots of stocks before Sept 11 and made a fortune after the disaster.
Not for just this reason alone, but it strikes me as morally offensive that someone should directly benefit from predicting that someone business/company will do badly, other than by investing in that company’s competition.
At least there, you’re rooting for a positive thing, improvement.
Does anyone else have a problem with this concept.
No, it’s an important part of the market mechanism.
If it makes you feel better, think of short sellers (when they’re right) as making an important contribution to future stock purchasers who would otherwise buy at an inflated price. It might also make you feel better if you realize that something like 90% of all people who trade in call/put options lose money.
The area where it should be, and generally is, disallowed is for high level employees to short their own company’s stock, since they are in a unique position to influence the negative performance of the company.
The overall market is best served when the pricing mechanism is allowed to expereince pressure from both sides. The key to the free market is the information contained in the price of a good or service. When a price is artificially constrained, people are unable to make optimum decisions about how best to utilize that good or service.
Short side of the equity market here. If I feel (as I do) that misguided investors have driven stocks to valuations that clearly are unsustainable, why should I not be able to act on that belief? Shorting also can serve as a hedging mechanism.
Disclosure: I shorted the S&P 500 earlier this month.
I’m net short at the moment. I have some longs, more shorts. I’ve made money every day during the past week.
If you analyze market conditions correctly, you’re rewarded. If not, not. You put your horse down, I put mine down. Whosever is fastest wins. What could be more fair?
As I explained to my son, the way to comprehend shorting is to think of it as taking out a loan in a foreign currency that you think is going to decline against the dollar. When you take the loan out, you get x number of dollars, because that’s what the currency is worth at that time. When the loan matures, you pay back your creditor with y amount of dollars, which are either greater than or less than what you took the loan out for, depending on whether the foreign currency in question rose or declined against the dollar by more than the loan plus the interest. If it rose, you lose. If not, you win. Simple. And fair.
options and futures/orwards are a zero sum game. For every short there is a long and vice versa. Not to belabor the point but if you don’t have a short position, there can be no long future or option position (of course, stock is naturally long). These are hedging tools that are also used by some people as speculators. I assume you have problem with the speculation part. regulation is the way to limit speculators to avoid exaggerated effects (circuit breakers, higher margining, covering requirements when short, etc.).
A healthy financial market requires the ability to hedge. Many investors/funds use short positions to hedge (rather than speculate).
That’s a realy good point which I neglected to mention in my earlier post.
Suppose you own a truck load of XYZ corp. The stock is up considerably since you bought it, but you don’t want to sell the stock because you think it will go up more. You also are planning to buy a house in a year or 2 and intend to use your gains from that stock as part of the down payment. A prudent strategy would be to buy some long term put options (ie, short the stock) as an insurance policy against the stock taking a plunge between now and when you buy your home. Depending on how much cash you’ll need, it’s pretty easy to do a calculation to determine just how many puts you should buy.
Let’s say that you own 1000 shares of a company, and you think they will be doing badly in the future. Is it morally offensive to sell your shares now?
If I’m playing craps at the same table as you while you’re shooting, will you get upset if I bet the “don’t”?
I think that “selling short” doesn’t mean selling your own shares. It means selling stock that you don’t own. Such stock is borrowed, usually from the broker’s own account and if the price goes down then you can cover the short by buying stock at the lower price and pocket the difference.
It is much more risky than owning stock. If you own stock the most you can lose is what you invested. If you sell short there is no theoretical limit to you potential loss because the stock can keep going up and up and splitting and going up some more. Most people who sell short put in a stop-loss buy order for a price somewhere above their sale price depending upon how much they are willing to lose. When the trigger price is reached a buy is made automatically to cover the short.
Something that doesn’t seem to have been mentioned: many institutional investors use selling short as an alternative to selling shares in the short-term to prevent overloading the market when they are rebalancing their portfolio.
Take the example of a pension fund. And rather than focussing on individual shares, take the example of a recently closed fund, where they want to change from a 70/30 equity/bond balance to a 50/50 equity/bond balance. If they were to see 29% of their shares overnight, they might depress the market. Even failing that, they may not be selling them at a good price. Also transaction costs may be prohibitive. Instead, they may sell short to effect the change immediately at little cost and with little effect on the market and then gradually sell the actual shares over the coming year to rebalance the underlying at a more sedate pace.
Am I right in thinking that a short sale is when you borrow shares from your broker, sell them, pocket the money, and promise to give the shares back (+ a fee) after a set period of time?
If so, why would someone borrow shares to sell if they already own a bunch of them? Either way, you will have to give up the shares you own, in a sale or to give back to the broker. I’m not seeing the advantage over just selling your own and putting the cash in a safe investment.
How does selling from your broker’s collection of shares not depress the market when selling the same # of your own will?
It’s not an issue of “rooting” for anyone. It has to do with probability and mitigating risk. Basically the McDonalds drive-thru version - If I am managing a portfolio of stocks, I can “hedge” against market downturns by shorting stocks I think are at most risk of performing poorly as well as maintain long positions on stocks I think will perform well.
Many people do - “bear” - person who tends to bet on a falling market - can be derogatory.
But I don’t really see why. The BinLaden thing is obviously a red herring. Would it be less reprehensible if he had bought bus company shares as opposed to shorting air company shares?
If you outlawed all stock trading that’s morally uncertain there wouldn’t be any left
People always seem to jump to the underlying mechanism when explaining short selling. It’s probably easier to understand if you consider the effect from your point of view before considering that. What happens is that you choose to take a short position, and you get the proceeds from the sale credited to your account, as well as an entry in your list of positions that you are short so many shares. There GENERALLY is not a set time period (I’m not discussing options here - just a straight short sale). The condition persists until you choose to purchase shares to cover the short position. If the price is cheaper than when you took the short position, you made money.
Easiest way to think about it is that you sold the stock, got the money, and have an “IOU 100 shares of XYZ corp” entry in your list of positions.
The next paragraph regards a “typical” broker’s policies, and could probably be modified by a a particular broker. It’s based on Schwab, whom I have an account with:
As long as you maintain the cash in your account to cover the short position, it doesn’t cost you anything, although the broker will not pay you interest on that money either. If you take the cash you got from the sale, and use it, or the stock price rises to the point that you don’t have the cash to cover, you are on margin, and are paying your broker’s margin rates. This is the reason you must have a margin account to short. The same rules apply here for maintaining margin as if you had bought securities on margin. If your margin limit is exceeded, bad things happen - the brokerage may start selling your holdings to pay it off.
Obviously, shorting is something you do with care, and most people put an absolute upper limit on how high the stock can go before they simply take their loss and cover.
Some wrinkles:
It is possible to be forced to cover, but it doesn’t happen very often.
If you short something which pays a dividend while you have the short position, the dividend comes out of your pocket. This makes sense, when you think about it.
It is possible that there is “no short interest” when you go to short something, and you won’t be able to do it. Here’s where the “borrowed shares” are germane to the discussion. Your broker cannot borrow the shares to sell, so you can’t get a short position. This usually means everybody else and his dog already figured out that something looks like a good short.
That’s a myth. The truth is that , on average, only 10% of options are exercised. This says nothing about profitability because most positions are closed out and only about 30-35% typically expire worthless.
Just to extend yabob’s answer in case Cheesesteak was addressing me: once you have sold short, you are in the position where you owe someone shares but you also own those shares. So as far as your balance sheet is concerned (and the investment effect too), you basically HAVE sold the shares – when it comes time to give them up, you just give over what you have.
The reason you would do this is that to dump a significant number of shares (particularly smaller issues) on the market would depress the price. You don’t want to do that. Also, it may simply not be a good day to sell that share. Much better, then, to do something that has the same effect without the negatives.
One way in which short sales actually distort the market is when a stock with a large short interest suddenly rises. This can cause a “short squeeze”, in which many shorts rush to cover, pushing the price up, causing many more shorts to rush to cover, and so on. There was an article in the WSJ the other day about a short squeeze at overstocks.com, which had a short interest of 50% of the traded shares (50% of company in owned by insiders). Then the CEO suddenly bought a huge amount of stock (about 3% of the company) which caused enough of a rise to set off a short squeeze, ultimately resulting in the stock rising about 80% with no change at all in the company’s fundamentals. (The CEO might be suspected of deliberately engineering this, and it certainly served his purposes, as the company is planning a secondary offering. For his part, he claims to have been arbitraging against a simultaneous short of amazon.com).
Yabob, I believe Cheesesteak’s post was a response to kabbes’ post above it. I agree with Cheesesteak - kabbes’s post does not make any sense at all, unless I’m missing something. On preview, it appears that I am not missing anything. Kabbes, when you sell a load of shares short you are dumping shares, and depress the market exactly as if you sold your own.
