I laugh
every time I get an email from the
public when the stock market goes down or crashes. These people think that they
are upsetting me saying things like, "How is that stock market treating
you?" Just that sentence tells me that the writer knows nothing about the
market or what I am doing in the market.
My market strategy has change a lot since the early 1970s and so has the market.
At that
time, the options market was not open like it is to the public today. Back
them, companies sold warrants in the market place and I could buy the warrants
or short them as I pleased. When a
warrant was about 2 to 3 years before expiration, I would short them. Then buy
them back 3 month before expiration. "I called it free money." But now hardly any company sells warrants
that I can borrow. The options market took its place. Oh, you don't know what I am talking about?
Let's take a class on short selling!
Selling stocks short is common in the trading world. When you
sell a stock short, you sell something you don’t have first and buy it later
with a goal of profiting from a falling stock price. To sell a stock short, you
borrow shares of a stock from your broker to sell them in the open market. Your
broker gets those shares from its own inventory, or from other clients.
The proceeds of that sale go into your account. To close that
position, you must buy the shares on the open market and return them to the
broker. If the price you pay for the stock, or the buy-to-cover price,
is less than your selling price, you’ve earned a profit on the short sale.
Conversely, if the buy-to-cover price is higher, you’ve suffered a loss.
Say you borrow 100 shares and sell the shares short for $100 per
share. When the price drops to $80 per share, you buy the shares back and
return them to your broker. You sold the stock for $100 per share and bought it
back for $80, netting a profit of $20 per share. It’s the same if you purchase
the stock for $80 and sell it later for $100.
Conversely, say you borrow 100 shares of Company Y and sell them
for $100 per share. The stock price rises to $120 per share, and you decide to
cover your loss. You buy back the shares and pay $120 per share, but you sold
them for $100 per share. You have lost $20 per share on this trade.
Some of the quirks that are unique to selling stocks short
include:
·
Paying
dividends to the lender.
If the stocks pay a dividend during the time a short seller holds
a position, short sellers pay the dividends on the ex-dividend date to the
people who loaned them the stocks. Short sellers need to keep the ex-dividend
date in mind whenever shorting stocks.
·
Being
forced to close a position.
Whenever the original owner sells the stocks you borrowed, your
broker can call away the shorted shares, which means your broker can
force you to return the borrowed shares by buying them on the open market at
the current price. This happens rarely and occurs only when no shares are
available for shorting.
·
Mandating
the execution of short sales from only a margin account.
Short sales must be executed in a margin account because your
broker loans you the stock to sell short and charges you interest on any margin
balance in the account.
·
Paying
margin maintenance requirements.
Your broker can force you to close a short position if you’re
unable to satisfy maintenance margin requirements.
·
Having
no or only minimal access to selling some stocks short.
Lightly traded stocks may be unavailable for selling short, and
when they can be sold short, they may be more likely to be called away (which
happens when the original owner sells the stock you borrowed and your broker is
unable to borrow additional shares).
·
Restricting
short sales on certain stocks.
You can’t short a stock that’s less than $5 per share, and you
can’t short initial public offerings (IPOs), usually for 30 days following the
IPO. And, as became evident during the credit crisis, regulators can prohibit
short selling on whole categories of stocks.
·
Limiting
short selling to only stocks on an uptick.
This uptick rule was eliminated in July 2007, but a
modified version was implemented again in 2010. The essence of the old rule was
that you couldn’t sell a stock short in a falling market. Short sellers could
not easily pile into a falling stock. The 2010 rule does not apply to all
securities.
Today it’s only triggered when a security’s price decreases by
10 percent or more from the previous day’s closing price. The rule then stays
in effect until the close of the next day. However, many people consider this
new version of the rule to be ineffective.
One unusual aspect of shorting is that it creates future buying
pressure. Every shorted sale must be covered, and that means that every share
of stock that’s been shorted must be repurchased. Future buying pressure can
cause the price of a heavily shorted stock to jump dramatically if all the
short sellers simultaneously clamor to get out of their positions as the price
rises, a situation called a short squeeze.
You can find out how many others are shorting the stock by
looking at short-interest statistics published in Barron’s and Investor’s
Business Daily near the end of each month. From those statistics, you get
some idea whether your short position is likely to be squeezed.
Now let's test what
you have learned here!
1. If a stock closed on Tuesday, July 14 and you want to short
that stock the next day. That means that, the short sell is only triggered when
a security’s price decreases by 10 percent or more from the previous day’s
closing price. (True or False)
2.
If the stocks pay a dividend during the time a short seller holds a position,
the dividend is not paid. (True or False) 
3. Short sales must be executed in a __________ account. A) Cash;
B) Margin; C) 401K: D) 521.
4.
Your broker can force you to return the borrowed shares by buying them on the
open market at the current price. That means that you may take a loss or a
profit. (True or False)
5.
All stocks can be shorted. (True or False)
6. Your broker can force you to close a short position if you’re
unable to satisfy maintenance margin requirements. (True or False)
7. You have not borrowed any money in a short sell so your
broker cannot force you to satisfy maintenance margin requirements since you
have no margin requirements. (True or False)
8. You can’t short a stock that’s less than $5 per share. (True or
False)
9. You can’t short initial public offerings (IPOs), for at least
30 days following the IPO. (True or False)
10. Short Sellers must understand that a loss when short selling
is unlimited. (True or False)
Answers
1. True
2. False
3. B) Margin
4. True
5. False
6. True
7. False
8. True
9. True
10. True
If you got
one or none wrong, you got an "A". You are ready to start short
selling.
If you got
two wrong, you got a "B". You
can start some limited shorting.
If you got three
wrong, you better use short with the help of a broker.
If you got four
wrong, read up on the subject before you short stocks.
If you got
more than 4 wrong, stock with buying stocks and bonds.
No comments:
Post a Comment