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Short Selling: The Zack Nardi Special. BOC Investing Education Committee. What is it?. Short selling or "shorting" is a way to profit from the decline in price of a security, such as a stock or a bond.
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Short Selling: The Zack Nardi Special BOC Investing Education Committee
What is it? • Short selling or "shorting" is a way to profit from the decline in price of a security, such as a stock or a bond. • To successfully short a stock, one must take a bearish stance on a stock, anticipating its price will fall. • Considered the opposite of “going long” (buying a stock anticipating it will rise)
How is this done? • Once a stock is identified, the investor must borrow the stock (any amount of shares) from a security lender and immediately sell it. • If the price goes down, the investor buys the stock at the lower price and then returns the shares to the lender, thereby making a profit. • Major security lenders include JP Morgan, Citibank, and Bank of New York.
Example • BSX currently sells for $17 a share. A short seller would borrow 100 shares of BSX from a lender and immediately sell those shares for $1,700. 2 weeks later BSX has dropped to $12 a share. The investor would then purchase 100 shares of BSX at $12 a share ($1,200) and then return the shares to the lender, turning a profit of $500.
Risks • The major risk associated with short selling is if the price of the borrowed stock rises after it is sold by the investor. The investor must then re-purchase the stock at the increased price in order to return the shares to the lender. • For example, if the price of BSX increased to $30 a share by the time the investor had to return the shares to the lender, the investor would have lost $1,300. • Potential to lose much more than by simply going long.
Notes • Typically done by day traders and hedge funds. • The lender will typically charge a fee for lending the shares. • Many short sellers place a “stop loss order” to avoid losing too much money from a shorted stock increasing in price.
Tick-Test Rules (Restrictions) • Tick-Test Rules dictate that a short sale can be made in only two situations: • When the price of the particular stock is higher than the last trade price (an uptick) • In a case where there is no change in the last trade price. The previous trade price must be higher than the trade price that preceded it (a zero uptick or zero plus tick) • This rule is intended to prevent investors from destabilizing the price of a stock when it’s falling
Definitions • Naked Short Sale – Selling a security short without first ensuring you can borrow the securities from a lender. • Short Ratio – The number of shares that have been sold short as a percentage of the total float. • Short Squeeze - A sharp increase in the price of a stock, caused by large numbers of short sellers covering their positions on that stock.
Why Short Sell? • We are all learning. Although this would not be our primary strategy, it is something that we should be exposed to at some point in our career to assist us in becoming a sophisticated investor. • It would allow for further involvement with the monitoring aspect of the market and economic trends. • Teaches us to identify "overvalued" stocks
Things to Remember • More than likely, short selling is not a long-term strategy. • Short selling has limited gains vs. unlimited losses. • Basic hold pattern of a short sell is to: • Hold the position until you have "made the desired profit"
