I just cannot, for the life of me, understand how you make a profit by it.
In: Economics
I undestand the princible and how the profit comes from it but I do not understand what is the gain/why bother?
I you have such clayorvance how the market will go, then might as well do options?
Seems to me the winner is the stock borrower who covers their stock decrease with the premium gained from borrowing?
The only applicable scenario I would understand is straight up market manipulation? But why would the stock borrower want have their stock value reduced possibly for long time?
It’s a form of gambling, really. You’re betting that a stock will sink in price. You do it by promising to sell someone that stock to someone in the future for a price that’s somewhere above what you think it will be when that future date arrives. Let’s look at an example:
* Stock S is trading at $100/share.
* Trader A thinks that by next week, Stock S will be trading at $50/share.
* Trader A offers to sell Stock S to Trader B at $75/share next week. Trader B accepts because he does not believe Stock S will tank and therefore that $75/share will be a fantastic price when the time comes.
* Outcome 1 – the short works: Stock S tanks to $50/share as Trader A expected. Trader A buys some at that price and then sells it to Trader B for the promised $75/share, turning a quick $25/share profit.
* Outcome 2 – the short doesn’t work: Stock S does not tank and remains at $100/share. Trader A is forced to buy it at $100/share and sell it to Trader B for $75/share, thereby losing $25/share.
* Note: Profit from doing this can go as high as the stock can tank (i.e. current price above zero, $100/share in this example is the max profit). Losses are potentially infinite because Stock S could rise in price to any theoretical number. i.e. if Stock S suddenly rises to $1000/share, then Trader A would lose $925/share.
Short selling is selling an asset you do not own, so basically to open the position you sell and to close it you buy. This is in contrast to a long position where you just buy to open and sell to close. In order to sell something you do not own you need to borrow it from someone who does own it. Why would someone encourage activity that depreciates their own asset? Because they get paid interest for that borrowing, short selling alone is rarely enough to tank the price of a stock so if you own a stock that would tank anyways, might as well make money from it, but also because most brokers, rather surreptitiously, have share lending on by default and most people don’t bother to turn it off. It can also be a simple bet for some passive income by the stock holder that they can get interest from lending their shares expecting that it will go up eventually anyways so it’s a low risk option for them.
So when you’re the short seller, you sell a stock at the current price, let’s say 10$. So now you have 10$ from selling the stock you do not own. Within a predefined time frame, you have to buy it back to return it to the person from whom you borrowed it. If you’re right in your prediction that the stock price will fall, you buy it back at a lower price than what you sold it for, so let’s say 7$. You also pay interest to the person you borrowed the stock from, let’s say 1$. So you sold for 10$, bought back for 7$ and paid 1$ in interest, which leaves you with a 2$ profit from the price of a stock falling.
Short selling, and short positions in general, are a necessary mechanism not only for hedging but also for gauging sentiment and market outlook. It mitigates risk somewhat because whether the market is going up or down there is a way to profit from it which encourages investment. However that is not to say there is no risk or that it is easy. It just means that people are a lot more likely to invest and participate in the market if they’re not relying solely on the hope that stocks will only go up.
You bet on a stock losing value. But i find it moronic since the gains are limited but losses aren’t. If you are right you keep the difference, minus the fee. But if you lose the bet you can get into immense debt
If you try to use leverage for get real gains you can dig yourself a 50k hole in a few days. It’s basically russian roulette for finance bros
Let’s say you borrow a toy from a friend.
You turn around and sell that toy for money. A certain window of time goes by, and friend asks for their toy back.
You now need to buy that toy to return it to friend. If you are able to buy it for less than you sold it for, congrats, you’ve made money.
My high school economics teacher explained it to me like this:
Your friend is going on vacation for two weeks and asks you to look after his Corvette.
While he’s away, you sell his car for $50,000. A few days later, Chevy releases a statement saying that that particular model is being recalled for faulty brake lines, and the value of the car plummets. Before your friend returns from vacation you buy the car back for $25,000 and put it back in his garage as if nothing happened.
You’ve just made $25,000 and nothing else has changed.
You make an agreement with the owner of a share to buy their share at some future point and pay them a fee to stick with the agreement.
Then you find someone who wants to buy a share and you sell them the share that you have arranged to buy. You’ll get roughly the amount of money this share is currently worth for this.
Then at some future point you do have to go through and buy the share. That might be more expensive than it was when you sold it or less, but if it’s less then you’ve made a profit.
So shorts make money when shares fall in value
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