Shorting Stock

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It’s not totally clear to me of what this is or how this works. And how to profit in the markets.

In: Economics

Essentially selling stock before you’ve bought it on the assumption that the value will drop.

Legal when done with stock options, illegal in most other situations.

You borrow stock instead of borrowing money. So if you think the stock is going to go down, you could borrow 100 shares at $100 apiece . . . then sell them right away and get $10,000. Once the stock goes down, you could buy 100 shares at, say, $50 apiece, then repay your stock loan. You have made $5,000.

If you bet wrong, and the stock goes up, you lose money. If you sell at $100, you get $10,000. But if the stock goes up to $150, you have to buy 100 shares at $150 to pay back your stock loan, and you will lose $5,000.

If you think a stock undervalued and set to rise in price then you buy it and gain as the value increases. Easy.

If you think a stock is overvalued then you need to get creative. The first response – buying options – works. You can also “borrow” shares. Someone who owns the stock and is confident in its value will lend you their shares of that stock for a set period of time and you immediately sell those shares to a 3rd party (e.g. “borrow” at $40 and immediately sell at $40). If you are right, then the price of the stock will drop and when the term of the loan is up you can go buy those shares at the new, lower price and repay the original lender.

Let’s say that $40 stock has dropped to $20, so if you borrowed and sold 100 shares you were paid $4,000 for them. When you bought them back to repay the loan you paid $2,000 leaving you a net profit of $2,000.

The risk is that your losses are potentially infinite which your gains are restricted to the difference between the original stock price and ~$0.00. (If you borrow at $40 the stock might go to $100 so you lose $60 for every share you borrowed, OTOH you cannot possibly make more than $40/share (if you bought back at $0.00)

You pay someone to borrow their stock.
You then sell the stock immediately.
When it comes time to return the stock, you buy back the same stock and return it.

If the stock value went down, you will pay less than you made selling the stock and make money.

You borrow shares of a company’s stock you think will go down, and sell it. When the stock does go down, you buy shares to replace the ones you borrowed. The difference between the proceeds when you sold and the cost to replace is your profit.

So if a stock is at $100/sh and you want to short 100 shares. You borrow them from your brokerage firm and sell, gaining $10,000. When the stock falls to $70, you buy to cover your short position and only spend $7000 on the replacement shares. The $3000 difference is your profit on the transaction.