Any bankers or sharedealers, please explain short selling?

[Bonzo Dog]

I just can't get my head round short selling. It is blamed for much of the turmoil in financial markets at the moment.

The BBC website has this in it's guide to short selling.

'So what is short-selling?

It is a technique that sees investors borrow an asset, such as shares, currencies or oil contracts, from another investor and then sell that asset in the relevant market hoping the price will fall.

The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference.

The same effect can be achieved without even borrowing the shares at all, but simply by using derivatives contracts - glorified bets. '



The basic flaw in the process seems to be ; why lend the asset in the first place? When it is returned it is worth less than when it was lent Ok so the speculator will share some of difference in falling price with the original owner, but they still have a depreciated asset. Seems crazy to me!!!!

Am I being thick and missing something. ? Please, can any one explain?

 

[Ross]

Been trying to understand that one myself. Hope someone can shed some light on it.

 

[Lionheart]

Bonzo Dog,

The way I understand it.

A short seller is placing a bet that the stock price will fall. But I don't know how they do this in the markets. More traditional investors that buy and hold stock (long sellers) are betting that the stock price will rise over time. I'm sure someone else can elaborate or please correct me if I'm wrong.

John

 

[hensylee]

I just can't get my head round short selling. It is blamed for much of the turmoil in financial markets at the moment.

The BBC website has this in it's guide to short selling.

'So what is short-selling?

It is a technique that sees investors borrow an asset, such as shares, currencies or oil contracts, from another investor and then sell that asset in the relevant market hoping the price will fall.

The aim is to buy back the asset at a lower price and return it to its owner, pocketing the difference.

The same effect can be achieved without even borrowing the shares at all, but simply by using derivatives contracts - glorified bets. '



The basic flaw in the process seems to be ; why lend the asset in the first place? When it is returned it is worth less than when it was lent Ok so the speculator will share some of difference in falling price with the original owner, but they still have a depreciated asset. Seems crazy to me!!!!

Am I being thick and missing something. ? Please, can any one explain?

they buy high, being pretty sure the stock will shortly fall, they sell. what they are also doing is sometimes spreading rumor that the stock share will fall - this is the illegal part. for that reason all short selling has been stopped by the federal govt of u.s.

 

[WayneGM]

Short selling is when you sell stocks you don't actually own. Instead you have to put up margin money (typically 150% of the current market value of the stocks) and in return the Brokerage firm essentially "lends" you the stock from their inventory to back up the sale. As mentioned in one of the posts above, the investor is betting the stock price will decline so the short seller is selling at a higher price and then buying it back to cover the original sale at a lower price. Typically it is a very short term strategy, often done within the same trading day.

Besides short selling, you can accomplish similar strategies in the Options or Futures markets.

 

[WayneGM]

I forgot to answer the last question....why lend the asset in the first place?

Essentially the brokerage firm acts as a clearing house. They are holding securities in bearer form for thousands of investors owning securities. They lend the stocks out of that inventory. The actual owner isn't involved. The Brokerage firm is protected as the margin put up by the short seller is 150% of the market value so if by chance they need to replenish their inventory to make physical delivery to the original owner while the short sale is still in place, they buy more share in the open market using the margin funds to cover themselves. If the price of the stock goes up instead of down, the short seller needs to bring in more margin money as they must maintain 150% margin based on the current market value, not the market value at the time the short sale was made. Hope that explains.

Ohh...I forgot......The Brokerage firm is at risk if the price goes up more than 50% and the short seller fails to put up the additional margin money to keep the 150% ratio. Accordingly, they are very quick to liquidate the short sale position, at the short sellers loss, if the price is rising and the margin calls have not be satisfied on time.

 

[Duff Man]

I still don't get it. I don't think I will ever.

 

[gadgetman]

sho't sellin'?????

sho't sellin'?????

Hells Bells.

ah thunk it was when yo' o'dered an' paid fo' 2000 poun's of Manure an' only got 1500 poun's delivahed, cuss it all.

Uh, wait a minute. Soun's about th' same af'er all don't it!!!!!!!

Bubba

 

[Dennis S]

Posted twice by accident.

 

[Dennis S]

Here is how I think it works in it's essence, though probably never this simple. Aaron is under the impression that the value of a certain stock is likely to fall. Dennis wants to buy some of that stock, and thinks it's value is stable. Aaron agrees (and becomes legally obligated) to sell me the stock, priced at it's current market value, even though he doesn't yet own it.

Aaron has some time allowed for delivery of the stock to me. He is betting the value will fall before he has to make delivery. If he is correct and the value does fall, he goes into the market, purchases the stock for it's now diminished value and delivers it to me.

If he made the right call, he sold the stock for (say) $100.00, then went into the market and purchased it for $80.00, thus pocketing a profit of $20.00 per share. In other words he found a way to make a profit by doing a better job of predicting the market than I did.

Note, however, that Aaron can quickly be in big trouble if his forecast is wrong. If that stock climbs in value, he may be in the market paying $120.00 for shares that he is obligated to sell to me for $100.00 per share. I think that is right, and hope it helps. Wayne has given a more accurate description of how it happens in real life.

 

[Freddie]

Short selling is when you sell stocks you don't actually own. Instead you have to put up margin money (typically 150% of the current market value of the stocks) and in return the Brokerage firm essentially "lends" you the stock from their inventory to back up the sale. As mentioned in one of the posts above, the investor is betting the stock price will decline so the short seller is selling at a higher price and then buying it back to cover the original sale at a lower price. Typically it is a very short term strategy, often done within the same trading day.

Besides short selling, you can accomplish similar strategies in the Options or Futures markets.

I forgot to answer the last question....why lend the asset in the first place?

Essentially the brokerage firm acts as a clearing house. They are holding securities in bearer form for thousands of investors owning securities. They lend the stocks out of that inventory. The actual owner isn't involved. The Brokerage firm is protected as the margin put up by the short seller is 150% of the market value so if by chance they need to replenish their inventory to make physical delivery to the original owner while the short sale is still in place, they buy more share in the open market using the margin funds to cover themselves. If the price of the stock goes up instead of down, the short seller needs to bring in more margin money as they must maintain 150% margin based on the current market value, not the market value at the time the short sale was made. Hope that explains.

Ohh...I forgot......The Brokerage firm is at risk if the price goes up more than 50% and the short seller fails to put up the additional margin money to keep the 150% ratio. Accordingly, they are very quick to liquidate the short sale position, at the short sellers loss, if the price is rising and the margin calls have not be satisfied on time.

Wayne has the textbook answer.
According to my 4th year Finance Major son.
He knows this stuff.

ALSO: It is not illegal to Short Sell, but it is illegal to Naked Short Sell, this is when a investor does not arrange the ability to short sell with their broker, known as a "locate". Freddie's Son

 

[Duff Man]

seems like this would require a lot of conspiring with a broker to make it work well, and the timing would be critical.

 

[Freddie]

From Freddie's Son
Yes, you right. Your broker is your best friend. You go out to lunch and
have him on speed dial.

[Hope your administrator doesn't mind me using my mom's name and answering your question]

 

[Bonzo Dog]

ALSO: It is not illegal to Short Sell, but it is illegal to Naked Short Sell, this is when a investor does not arrange the ability to short sell with their broker, known as a "locate". Freddie's Son

Have you perhaps highlighted the nub of current problems, not enough checks and balances, ie de-regulation leads to avarice?

 

[OldManEmu]

Short Selling

Short Selling

In Australia brokers are not the sole facilitators of stock lending. Usually it is hedge funds that borrow stock off superannuation (retirement funds, long term investors), hedge funds pay a fee to borrow the stock for a set period of time then sell it and hope to buy it back at a lower price with the expectation that the lower price will cover the borrowing fee and make a profit by the end of the borrowing period. The superannuation fund gets a guaranteed fee up front in return for loaning the stock and gets the stock back at the end of the agreed loan period. Superannuation funds tend to be fundamental investors (long term) they believe in the long term the stock will return to its fundamental valuation despite the havoc that the hedge fund short selling may have caused in the interim. If however the hedge fund can't return the stock at the end of the load period or pay another agreed loan fee to roll the loan over this is when things start going bad.

 

[WayneGM]

seems like this would require a lot of conspiring with a broker to make it work well, and the timing would be critical.

Actually, there no conspiring at all but timing is indeed critical. Short selling is a fairly common strategy and isn't really all that complicated. I guess I should mention I have an investments brokerage background. All the short selling client has to do is disclose it is a short selling trade and put up the cash margin. I had "speculator" clients who used to do it all the time. Brokers rarely advise clients to short sell as an "investments strategy" so its pretty much only the speculators or professional traders who do this. I simply took the order and made sure they were properly margined. Think of short selling as borrowing to invest (called leveraged investing), except you are borrowing the stock instead of the cash. Like all leveraged speculative investments timing is everything, but its no different if you are borrowing the cash on margin from the brokerage to buy a stock in anticipation of a short term price rise (the brokerage holds the stock you purchased as collateral) or you are borrowing the stock to short sell in anticipation of a price fall (the brokerage holds your cash as collateral).

 

[Bonzo Dog]

................. I guess I should mention I have an investments brokerage background. ..............

Wayne, a hairy, Harley riding, investment broker. Sir I salute your contradictions.

 

[WayneGM]

Wayne, a hairy, Harley riding, investment broker. Sir I salute your contradictions.

My friends used to call me the "Bay Street Biker" when I worked there. (Bay Street is Canada's Wall Street). Besides if a Harley was good enough for Malcom Forbes, it's good enough for me!

 

[OldManEmu]

Stock lending

Stock lending

Wayne in Australian there is no requirement to "disclose it is a short selling trade". The loan of stock is "off market" for a fee and doesn't have to be declared to anyone. The stock that is loaned is still owned by the original beneficial owner, just loaned to another party for a fee for an agreed period.

 

[WayneGM]

Wayne in Australian there is no requirement to "disclose it is a short selling trade". The loan of stock is "off market" for a fee and doesn't have to be declared to anyone. The stock that is loaned is still owned by the original beneficial owner, just loaned to another party for a fee for an agreed period.

Interesting. The process sounds more formal than on the North American exchanges. I can't speak to other jurisdictions. Does the beneficial owner then know that their stock has been lent and do they get part of the fee? Here, because the brokerages are using bear securities in inventory, the underlying owner has no idea.