Sunday, July 13, 2008

Shorting Stocks for Fun and Profit

Lets face it 2% interest in the bank ain’t going to pay for juniors new shoes. So in today’s market (that Bernanke claims is doing so great) a lot of investors are shorting anything that deals in finance. In order to sell stock short that you don’t own, you need 40-50% of the stocks present value deposited in a brokerage account (you also need to sign a statement that says you know all of the rules, so you need to be able to comprehend what you read).

If you wanted to short [Insert financial stock name here] currently trading at $25 you would need $1250 cash to do the transaction. If the stock went up, you have to cover the increase, or your position would be sold out. If it pays a dividend, you are liable for that cost also on the day of record. Let's figure that the stock dropped to $19 and you covered and bought it back, your net would be $600 less brokerage fees. Try to keep a couple of thousand in reserve, for a cushion. Don't get greedy. Not everything goes down (that includes most of my dates in college).

Shorting stocks in a down market is just like buying stocks in a rising market. You can make money. The trouble is, stocks don’t always do what is expected of them. If you short a stock with only 20 or 30 million shares issued, you could run into a bear squeeze. A few large investors see a large short position and start buying the stock like crazy and it takes off and really burns the shorts. The easiest way to accomplish the same thing is for the perpetrator to have a very large position of stock in street name. After it has been shorted by everyone and anybody, the perp calls up the broker and asks for delivery of the certificate. Bear in mind, in this special circumstance, if your brokerage loaned you the perps stock, you could be forced to buy back the short on the spot (read the fine print). In this case, the supply just dried up and the price is going to take off big time. A real loser goes ballistic.

If the stock jumpes above your cash reserves, your brokerage firm can sell you out without asking you. This can be real aggravating if the stock jumps up $10 and you get liquidated. Then later in the day it drops below you initial short value.

In 1929 a bunch of people with short positions got caught when a particular stock took off and went to $900 and the exchange settled with the shorts at $100 a share. I believe the company folded months later. $15 would pay your rent for a month back then.

Is there any reason at the present time why financial stocks should go up in price??? I can guarantee the larger your short position, the less you sleep at nights. The risks are real.

As a cautionary note this is not investment advice. I'm just showing you what other people in the market are doing. It's a little like learning to play poker; it can be fun if you are not trying to use it to pay the rent.


I'm Not POTUS said...

I have not the time nor the brass ones to play shorts all day long.

I am content to pay professionals running the ProShares ultrashort and short ETF's. I don't play next months rent but I just like the feeling of having a small portfolio that has outperformed 97% of the professionals since March.

If I get creamed in a bear trap, I have the recourse to blame and curse Proshares for my follies. Not much of a compensation but at least it will make me feel better.

What is your take on L.E.A.P.S.?

I'm Not POTUS said...

FYI Jim,

I just penned my tribute to Greenspan. Hope you like it.

Tyrone said...

My SDS is doing well. Whadya' think... S&P 500 down to 1000? 900? ..

Jim in San Marcos said...

Hi Potus and Tyrone

I haven't really explored how Proshares link to the real markets. A lot of indexes can be run off of other indexes and from there you get into derivatives.

I avoid the middle man. I play with what I know. I hope that SDS works out for you both.

Looks like we are headed for some rough sledding ahead, the SEC is limiting what you can short

The Greenspan post is cute--blogging will get to you