Shorting Stock What does it mean to short a stock?
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- You've probably heard the term short sale, and have at least
- a general-- oh, what did I do with that?
- Oh there it is, I scrolled down-- you probably have a
- general idea that it means, to some degree, making a bet that
- a stock will fall.
- And there's been a lot of news lately that maybe short
- sellers are to blame for a lot of the stock market crashes,
- or what's happening with banks.
- So I thought it would be worthwhile to at least explain
- what a short sale is.
- And then we could talk a little bit about whether
- they're positive or negative, or they could be both.
- So you are right if you think that a short sale is some type
- of a bet that a stock can go down.
- But how does it work?
- So let's say that, I don't know, IBM-- and I don't know
- where IBM is trading right now-- but let's say IBM is
- right now-- the last trade was at $100.
- And I'm convinced.
- I've done my research, I've done my analysis, and I'm just
- convinced that the stock price of IBM is going to fall.
- I think IBM is going to have a horrible quarter next quarter.
- That some other competitor is going to take
- their business, whatever.
- I'm convinced it's going to fall to $50.
- This is what I think.
- I think it's going to fall to $50, based on
- my deep stock analysis.
- And so, the general idea is that I should-- well I won't
- make any value judgment right now-- but I want to know if
- there's a way that I can make money off of my deep analysis.
- And the way I do that is I go to my brokerage-- so let me
- draw some diagrams. So this is my brokerage, this is my
- broker, and this is me right here.
- This is me.
- I have a top hat.
- Anyway, so I go to the broker and I say broker, I would like
- to short IBM.
- I would like-- let's just say for simplicity I want to short
- one share of IBM.
- So what I do is I go to the broker, and I say broker, can
- I borrow a share of IBM?
- And this is a little unintuitive the first time
- people learn about it.
- It was a little unintuitive for me the first time I
- learned about the notion of borrowing a share.
- But you can also view it as renting a share.
- And you might say well, where's the
- broker getting it from?
- Well this broker's got a ton of clients.
- Let me draw some of them.
- His eyes were strange.
- OK, so this broker has a ton of clients,
- many of whom own IBM.
- And they keep their shares of IBM with the broker.
- So the broker always has-- let's say each of these is a
- share of IBM.
- And these guys are all owners of IBM.
- And if ever, one day, this guy wanted to sell his share of
- IBM, the broker would go out there, sell it in the market,
- or maybe this guy would sell it,
- depending on how it's done.
- And then this would be replaced with the money, and
- this would then become $100, right?
- And then if IBM issues a dividend, if it says OK, all
- of our shareholders will get $5.00 from a company.
- And then each of these guys would get $5.00.
- So they're all just shareholders in the company.
- And also, just so you know, as opposed to being short the
- company, they're long.
- When you go long a
- security, you're buying the security.
- When you go short, as you'll see, you're borrowing the
- security and selling it.
- So let's see how that works.
- So once again I go to my broker and I say broker, I
- want to borrow a share of IBM.
- And the broker says OK, well I've got all these share
- sitting around here.
- And they're really not doing anything.
- I'll lend you this share right there.
- And stick it in my account.
- And I'm going to have to pay rent to borrow that share.
- You can kind of view it as either interest on borrowing
- the share, or you can view it as rent.
- Rent is sometimes more intuitive.
- Because whenever we talk about when you rent someone's
- apartment, you're really kind of borrowing their apartment.
- Then you can kind of view the rent as the
- interest on the apartment.
- Or the other way to view it, when you borrow money, the
- interest is kind of rent on the money.
- Anyway, I think you get the idea.
- But I'll borrow this.
- And you'll say hey wait, Sal, that doesn't make sense.
- How can you just borrow this guy's stock?
- I mean, this guy might want to sell it the next day.
- And that's a good question.
- If this guy wants to-- let's say I borrow his stock, it's
- not sitting there anymore.
- If this guy wants to sell his stock the second after I
- borrow it, the broker is just going to take-- he's just
- going to shuffle around the stocks a little bit.
- I mean, you know stocks are-- they call it fungible, you can
- replace one stock certificate with the other.
- They're no different.
- So then he'll say OK, I'll just give this
- stock to this guy.
- I just messed up with my pen.
- I'll just give this stock to the guy who wants to sell it,
- and then you would have essentially
- borrowed from this guy.
- And you could keep rearranging the securities so that none of
- these guys ever know that their stock is borrowed.
- Although you have to give permission, especially if
- these guys own the stock outright.
- They have to give permission to let the stock be borrowed,
- and they benefit, because they get some cut, hopefully, they
- get some cut of the rent, or the interest that I'm paying.
- So it's beneficial to them.
- And the broker can never, well it should never, really, lend
- out all of the shares here.
- Just so that it can keep shuffling around.
- And we'll talk about what happens if you actually try to
- do this with a share that you've never borrowed.
- We'll do that in a future thing.
- But the general idea is, you borrow one of these shares out
- here, and then the broker can kind of keep shuffling around
- these shares, if any of these guys really want to get rid of
- their share.
- And let's say I've borrowed this guy's.
- Let's say I originally borrowed this guy's share.
- This guy wanted to sell his share.
- So what the broker does is, he takes this share, gives it to
- him, and now I have officially borrowed this guy's share.
- This is the share I'm borrowing now because this
- one's been sold.
- Now, what happens if IBM issues a dividend?
- It says every one of our shareholders should get $5.00.
- Well this guy's expecting a $5.00 check.
- Or he expects $5.00 to be deposited in
- his brokerage account.
- For that to happen, I essentially have to write this
- guy the $5.00 check.
- So I have to make it look, or at least the broker is going
- to force me to make it look like this guy
- still owns the share.
- So anything that this guy gets by being a shareholder of this
- stock, I have to provide for him.
- Anyway, so I've borrowed the stock.
- Now what do I do with it?
- My whole thesis here is that IBM is going to $50, so how do
- I make money off of that?
- So I said it is
- trading right now at $100.
- I've borrowed this share.
- So I sell it.
- So let's see, the first thing is I borrow one share, as I've
- done there.
- And now I sell it on the market.
- And we said it's selling for $100.
- I sell it for $100.
- So I sell it to the market.
- Let's say the market is out here to the left.
- So I sell to the market, and I get $100.
- So let's see what's happening right now.
- What's my current state of affairs?
- Let's say assets-- and I'll talk about margin requirements
- later-- liabilities.
- What do I have, what do I owe?
- So now I have $100.
- And what do I owe?
- I owe one share of IBM.
- Let's say my analysis ends up being correct,
- often times it won't.
- And we'll talk a little bit more about why short selling
- can be extremely risky.
- But let's say my analysis is correct, and a couple of days
- later IBM starts trading at $50.
- What I can do now is unwind my trade, or cover my short.
- And the way I do this, is I have $100, right?
- What I can do is, I can then just go out there and buy my
- shares of IBM back, right?
- So I buy one share of IBM.
- And how much do I have to pay?
- Do I have to pay $100?
- Well no, the share of IBM stock price
- has dropped to $50.
- So actually, let me do that.
- I'm not paying $100 out, I'm going to pay $50 out.
- And I'm going to get back a share of IBM.
- I'm going to get back a share of IBM, and that's what I owe.
- So I'll give it back to my brokerage.
- So I will go out, spend $50, get back a share, and then
- give that share back to the brokerage, give it
- back to that guy.
- These guys never knew that anything happened.
- And in the process, what happened?
- I sold the shares for $100, and I bought
- them back for $50.
- So after unwinding this whole thing-- I used $50 of this
- $100 to buy the shares back.
- So how much do I have left?
- I have $50 left.
- And I returned the shares of IBM, so I owe no one anything.
- So I made $50 off of this trade.
- So traditionally in the stock market, on the long side you
- want to buy low, sell high, right?
- When you're short selling, you're doing the same thing,
- but you're doing it in reverse.
- You want to sell high and buy low.
- Anyway, hopefully that gives you the general idea of the
- mechanics of short selling.
- In the next video I'll talk a little bit more about what--
- this was a very good scenario, where what I wanted to happen
- did happen.
- But in the next video we'll talk about the risks of short
- selling, and maybe a little bit of a discussion of whether
- it really is good or bad for the markets, or for
- society as a whole.
- See you in the next video.
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