"Short-selling is on the decent-sized list of practices which seem bizarre to civilians but to insiders are a routine feature of how modern markets work. A short-seller borrows shares in a company, and then sells them, with the intention of buying them back at a cheaper price, returning them to the lender, and trousering the profit. Say you decide that, to take one purely hypothetical example, News Corp is overvalued because – oh, I don’t know, just to make something up – because all its senior management are going to go to jail. The current price is $15.80 and you reckon it’s heading for ten bucks. So you find a willing lender, borrow one million shares with an agreement to return them on a specific date, and then you sell them. Notice that this selling is not a neutral event: by dumping $15.8 million of News Corp stock you actively help to drive prices down. Critics of short-selling point out that this shades into a form of market manipulation, which is illegal. A short-seller isn’t just betting on an outcome, he (it’s usually a he) is trying to bring it about. Anyway, some months pass, the News Corp execs are charged with multiple malfeasances, the stock tanks to $10, you buy back the million shares – this is called ‘covering the short’ – and give them back to the lender."
—John Lanchester explains short-selling in an extremely depressing analysis of our horrible economic outlook.
Wednesday, August 31, 2011
17
Note that the same analysis applies to buyers ("longs") as well. If I buy a million shares of NewsCorp at $15.80 because I think their senior management is likely to skate and the stock is going to go to $20, buying a million shares will likely drive prices up. That's how prices come about in a market.
@alkali19@twitter The difference is leverage - it costs you real money to buy outright. With Shorts you just borrow the stock from your broker who charges lnterest on the loan. There is much greater risk to a short.;
@grandpa27 You can buy stock on margin as well as sell short.
My point was that if short sellers are "manipulating" the market because their selling can affect the market price, the same is true of longs, whose buying can affect the market price.
@grandpa27 - But the interest you pay on the loan is a real cost. You also have unlimited loss potential in a short.
If you buy a share of NewsCorp for $15.80, your maximum loss is $15.80. If you short a share at $15.80, your potential losses are theoretically unlimited because you have to buy that share at the current market price, whether it's $15 or $1500.
@alkali19@twitter Yay, another Awl post on an economics issue where I can jump in late with a point someone else has already made! So yes, buying raises the price in the same way that shorting lowers it.
Anyway, ANOTHER important thing to note here is that more shorting could have really reduced the impact of the housing bubble. There were a fair number of people who knew the whole housing thing was a mirage, but very few had the balls to actually short any of the companies/securities involved, because if their timing wasn't perfect they could lose a lot of money. Instead, if you realized in, say, 2006 that there was a housing bubble brewing, the smarter strategy was just to buy in and then get out at the top once things started to turn -- thus helping to further inflate the bubble. A buy is a bet on 'up,' but a properly functioning market needs a way to bet on 'down' too!
Another thing that civilians find puzzling: using "trouser" as a verb. I guess this is what Knifecrime Islanders say when Americans would say "pocket"? Do KCI pants (sorry, trousers) not have pockets? Or do Brits not keep money in their pockets, because their pockets are full of knives? SO MANY QUESTIONS!
@jfruh Sell your shorts and pocket the trousers?
These verbnouns or nounverbs are confusing/irritating. The one I hate most is "rubbish" as a verb meaning to denigrate. Or badmouth. Which, I suppose, is an adjectivenounverb.
trousering = putting the reward in your pocket. Conversely, Putting pants on an drunken companion.
...whereas "pantsing" is the act of swiftly dropping same trousers to drunken companion's ankles.
I think thats a poor description because you fail to indicate that short selling is simple manipulation of a broker accounting function. That is the foundation of short selling. The other stuff is all about motivation and sentiment which is really immaterial to understanding the mechanics of short selling.
Ordinary buy = buy stock and (hopefully) sell it later for a higher price = profit
Short sale = sell a stock and (hopefully) buy it back at a lower price = profit
Accounting goes like this
ordinary
Account
Buy 1m @ $10 DR ($10,000)
Sell 1m @ $13 CR $13,000
Profit Bal $3,000
Short sale
Sell 500 @ $10 CR $5,000
Buy 500 @ $7 DR $(3,500)
Profit Bal $1,500
Note in short selling your broker needs to deliver the shares they have sold to the buying broker.
Since you dont have the shares you sold - the broker will 'borrow/rent' the shares to complete the delivery and balance it's books with the other broker. When you finally buy-in your short - the broker will unwind the renting deal by delivering what you just bought.
I was the king of short-selling in my high school economics class, which should indicate something of my faith in and opinion of individuals and institutions.
ok, can someone explain who these people are who are loaning the stock? what's in it for them?
@GandS: Just as you would expect, the lenders of the shares are brokers whose clients may own the shares already, or who can get them quickly from other brokers. These brokers often charge the borrowers fees for providing this lending service. It's a pretty good business to be in, as long as the shares aren't especially difficult to obtain.
@skahammer just to clarify by broker skahammer is not talking about stock brokers. It's investment banks/ brokerage houses who actually hold the stock. You as a client sign away your right to earn any interest on the loaning of any specific stock you own. They bank receives the interest.
I don't know if this works in quite the same way as options markets do--or used to: I'm not even sure if options markets are still a going concern, but I worked in one for half of the 90s, and in the ensuing years have managed to scrub my memory of most of the traumatic experience. But at risk of triggering more PTSD, the way it worked (and which it might have in common with the short selling described above): a customer could buy or sell the right to buy or sell a stock at any price whatsoever. That "right"--the option--would cost the customer an amount equal to the difference between the actual current stock price and whatever price the customer attributes to it in the option, plus a "premium value". The premium value is a price figured out by formulas devised by Nobel prize winners, based on things like interest rates, stock volatility, dividends payable, and the length of time until the option expires. Anyway, something like that (or maybe just a broker's fee?) is prob'ly what would be tacked on to the loan of stock to a borrowing short seller.
Whew, I'm palpitating... take me elsewhere, internet!
So, if I have enough money to pay the interest or whatever, could I borrow all the stocks in the world, then drive them down to zero by selling it all at once, thus converting the entire wealth of the world into a worthless pile paper serving only as proof that "I win"? Next world, please! It's called Free Market, crybabies: we will all die anyway, all that matters is who wins games. Or maybe you found the meaning of life? Pfft.