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Finance and capital markets
Unit 9: Lesson 1
Put and call options- American call options
- Basic shorting
- American put options
- Call option as leverage
- Put vs. short and leverage
- Call payoff diagram
- Put payoff diagram
- Put as insurance
- Put-call parity
- Long straddle
- Put writer payoff diagrams
- Call writer payoff diagram
- Arbitrage basics
- Put-call parity arbitrage I
- Put-call parity arbitrage II
- Put-call parity clarification
- Actual option quotes
- Option expiration and price
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Basic shorting
When you short a stock, you are betting that the price of the stock is going to decrease. In this video, learn about the basics about shorting stocks. Created by Sal Khan.
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Why are you allowed to sell something that you borrow? Also if I do sell something that I borrow there are now 2 people that think that they have 100% ownership of the same thing. Did I just create an imaginary stock?(83 votes)
Think of it this way. You lend me a sandwich and I immediately sell it for $5 promising you I will return an equivalent sandwich someday. Meanwhile, Oprah says everyone should eat tacos instead, and the price of sandwiches drops to $2. I buy a $2 sandwich and pay my sandwich debt to you yielding me a $3 profit minus whatever interest you were charging.(236 votes)
looks like this video is a follow up to some previous lesson, anyone know what that lesson/video is?(25 votes)
What if you use the American call option as well as shorting a company? Then you get limited downside too.(10 votes)
Exactly, that is what many people do - this is called hedging - it is especially useful protecting your position against Black Swan events (very unusual, extreme swings in the market) when trying to cover your shorts (by buying back your stock) may be hard if not impossible. This happened with POT (Potash) when a very significant takeover bid occurred overnight and folks who were short could not cover their positions (even with sell orders) whereas those who had protective puts in place were totally hedged.(16 votes)
- I wonder how naked short selling works, i.e. selling without borrowing the stock? How do you do that?(14 votes)
- Naked short selling means that the firm is short selling the stock without locating a borrow. I think it is illegal and theoretically more shares can be shorted than exist.... this was alleged by some smaller companies such as Overstock(7 votes)
- is it possible to borrow the stock and then sell it without buying it later when it goes down. You will get the entire price of the stock without buying it in the beginning.(7 votes)
To further his point, it's stealing because a stock is someone's property. It belongs to someone and that person isn't going to risk you losing his/her investment.(2 votes)
Isn't it true that you need to set up a margin account of which your broker has control when you short securities.(3 votes)- They do it so they can ensure that you can pay your debts if you lose. The risky thing with options is the fact that you can highly leverage your money, which means either a large profit or a large loss compared to stocks where there is no leverage available.(2 votes)
Why don't people just buy the stock, and actually own it, and then sell that stock? that way you would have no obligations to buy it back.(3 votes)
They don't want to own it. Shorting is the opposite of owning. They think the stock price will go down. Therefore they want to sell before they buy, not buy before they sell.(5 votes)
- What is the benefit of the other party lending you that stock? If they are literally just giving it to you for you to then return it at a later date at the same value what is there incentive to lend it whilst you go off and attempt to short it and make money?(3 votes)
- they get interest, just like you do when you lend money
However, in a retail brokerage account, it's usually the broker who gets to keep the interest, under the rules of the brokerage agreement.(5 votes)
Why would people short? Also, do the people who are shorting have to tell the real owner/lender that they are shorting the stock? Third of all, is there interest? Like if I lent my stock to Person 1, and the stock is worth $50, would the person have to pay me back with interest or not? Because if there's no interest, I don't see why people would lend THEIR money, when there's risk of bankruptcy and no chance of profit. Finally, who decides the interest (if there is interest at all)? Thanks!(2 votes)- If you think the stock is going to go down, you might want to be short.
The owner, or the representative of the owner, knows that the stock has been borrowed.
The borrower pays interest. When you own stock in a brokerage account, typically your deal with your broker allows your broker to lend out the stock and keep the interest. If you are a large customer you might be able to negotiate a deal where the interest comes to you.
The lender is not lending money, the lender is lending stock, and there is no risk to the lender because the stock always remains in custody of brokers, and the short seller always has to maintain more than enough equity in his account in order to cover the cost of buying back the share to return them.(4 votes)
- The only question I have is this: What if you want to buy the stock back, but the other person isn't willing to sell it? Then what happens?(2 votes)
- This can happen on a large enough scale (eg it seems like no one wants to sell), and what occurs is called a "short squeeze". Basically, if you short sell a stock that has a binary positive event (a drug passes clinical trials, it gets a big acquisition offer) then tons of people want to buy the stock. However, if the stock is one that is heavily shorted (a lot of people also bet against the stock) and doesn't have a ton of shares outstanding, then tons of people will be looking to cover their shorts while no one will want to sell (because the stock keeps going up). In this case, the price can rise very rapidly, much higher than seems reasonable even given the good news. The price will typically recover down to its fair price eventually, but that brief period could wipe you out entirely. This happened in 2008 when Porsche offered to buy the balance of VW, VW was heavily shorted, everyone tried to cover at the same time and no one wanted to sell and VW shares went from about 200EU to over 1,000EU and for a couple of days VW was the most valuable company in the world.(3 votes)
Video transcript
Let's say you don't like
company ABCD very much and you're convinced that the
stock is going to go down. So in that situation, you
can actually short the stock, which in a very
high level is a bet that the stock is
going to go down. And the way that you
do that mechanically is that you borrow the stock
from someone else who owns it, and then you immediately
sell that stock that you don't even own. You sell the stock that you
borrowed from someone else, and you'll sell it
at the current price. So, for example,
in this situation, you would sell it at the
current trading price of $50. You would then hope that
the stock price goes down. Let's think about
the situation where the stock price goes down. So if you shorted it right over
here, you borrowed the stock and you sold it for $50. And then if the stock were
to actually go down-- let's say it goes all the
way down to $20, and you think that's about
how far it's going to go down, then you can buy back the stock
for $20 in this situation. And then give it
back to the owner. You had borrowed the stock. Now you can hand back
the stock to the owner. So you could give it back and
you've essentially unwound it. And what it allowed
you to do is it allowed you to do the buying
and selling in reverse order. Normally before
you sell something you have to buy something. But here you were able to
sell it and buy it later for a lower price. So the situation
where the end price is $20 you had sold it for $50. So you got $50. And then you had to use
$20 of it to buy it back. So in that situation,
shorting the stock, you would have made $30. Let me write this column here. This is the short option. You sold at $50. You borrowed and sold at $50. Then when it went down to $20
you bought it back for $20. So you had $50 of proceeds. You had to use $20
of it to buy it back. So you had a $30 profit. But that's only in
the good scenario. What happens if
your bet is wrong? What happens if the stock
price goes up to $80? And over here you get so scared. You're like, oh my god, I have
to buy the stock back by $80. What if it keeps going up? I could lose an unlimited
amount of money. So over here you get scared
and you unwind your situation. You say, OK, I'll go and
buy the stock for $80, so I can give it back. So in this situation
where the stock goes up you actually could
lose a lot of money. You had sold it for $50. So you only have $50 that you
have from the transaction. But now you have to
buy the stock for $80. So if you sold for $50
and you buy for $80 you've now lost $30. You're $30 in the hole. So now you are at negative $30. And really shorting is the
riskiest of all of the things you can do, because a stock
price and go unbelievably high. What happens if the stock price
goes to $800 or goes to $8,000? All of a sudden, you've
sold something for $50 and you have the obligation
at some point in the future, because you have to
give the stock back, of paying $500, or
$800, or $8,000. You don't know how much
you'll have to lose. So it's really the
riskiest thing you can do. But it is one way to bet that
a stock price will go down, or profit from a stock
price going down.