Eli5: What’s and how shorting a stock is/works?
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Imagine you think the price of a company’s stock is going to go up, you would probably buy some stock, hoping to sell it later for a profit. Now imagine you think the price is about to go down, you’d probably sell it before you lose money (or lose potential profit). In this case you actually still “make money”, because you can buy the shares back later for a lower price when the price goes down. You still have the shares, plus some additional money.
What happens if you think the price will go down, but you don’t already own any shares? What you could do is borrow the shares (promising to return *shares* not money). You can sell the shares immediately, wait for the price to go down, then buy them back for cheaper. When you return the shares, you pocket the difference. This is called shorting.
Shorting a stock is taking out a short term loan. You’re borrowing from your broker, but instead of denominating the loan in dollars you’re denominating it in shares of a company.
After your broker agrees to lend you the shares, you sell them in the open market. At some later date you repay the loaned shares to your broker.
You usually do this because you need to borrow money from your broker to fund other positions and/or because you believe the stock will go down. There are other reasons you might short a stock having to do with risk management.
It’s borrowing shares of stock to sell, with the idea that you’ll be able to buy back shares to pay back the loan when the stock is at a lower price.
You borrow shares from your brokerage in the way you might borrow money from a bank. You borrow 100 shares of XYZ Corp. You sell those shares for $80/sh and pocket the proceeds ($8000), but owe the brokerage X number of shares. A couple months later the company’s stock falls to $55 and you buy to cover your short position. The cost was $5500. So $8000-$5500 means you profited $2500 from the transaction.
Everybody here has already covered short positions from borrowing stocks, but I’d just add that in general, a “short” position is any position where you make money from a decrease in price of the underlying asset, and there are a few ways you can do it.
A few examples, all based on shorting a single stock currently selling for $50:
– You can borrow the stock and sell it for $50. As discussed in the other comments, if the price drops, you buy the stock back and repay your loan.
– You can make a deal to sell someone a stock for a given price at a given date, for example, $45 one month from now. If the stock price falls to, say, $40, you buy the stock and sell it for $45 at the closing date. If the stock stays at $50, you still have to sell it for $45 at the closing date (losing $5).
– You can buy an option to sell a stock at a given date for a given price. Similar to the above example, but this time, you might pay $3 for the *option* to sell a stock for $45 in one month. If the stock falls to $40, you make $2 ($5 profit less the $2 you paid for the option). If the stock stays at $50, you don’t exercise the option and you lose $3 (the price you paid for the option) as opposed to $5 (your losses under the contract option above).
– You can sell someone the option to buy a stock from you in the future. This time, someone pays you $3 for the option to buy the stock at $45 one month from now. If the price stays at $50, you lose $2 (you sold the stock at a $5 discount, but you made $3 selling the option). If the stock falls below $45, you make $3 (the buyer will just buy the stock for cheap on the open market, and you keep the price they paid for the contract).
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