Going Short

Going Short

Going short, also known as short selling, is a trading strategy used by investors who anticipate that the price of a security, such as a stock or a commodity, will decline. When an investor goes short, they sell a security that they do not currently own, with the intention of repurchasing it at a lower price at a later date. If the price does indeed fall, the investor can buy back the security at the reduced price, returning it to the lender, and pocketing the difference as profit.

Examples§

1. Short Selling a Stock

   • An investor believes a particular company’s stock is overvalued at $100 per share. They borrow 100 shares and sell them, receiving $10,000. Later, the stock price drops to $80 per share, and the investor buys back the 100 shares for $8,000. The investor returns the borrowed shares and keeps the $2,000 profit (excluding fees and interest).

2. Short Selling a Commodity

   • A trader expects the price of crude oil to fall from $50 per barrel. They borrow 1,000 barrels and sell them for $50,000. If the price drops to $40 per barrel, the trader buys back the 1,000 barrels for $40,000, returns them to the lender, and retains the $10,000 difference as profit (excluding fees and interest).

Frequently Asked Questions (FAQs)§

Q1: What are the risks of going short? A1: The primary risk is the potential for unlimited losses because there is no theoretical limit to how high a security’s price can go. If the price rises instead of falling, the investor must cover the position at a higher price than the selling price, resulting in a loss.

Q2: Can any investor go short on stocks? A2: Most brokerage accounts allow for short selling, but the investor must meet certain margin requirements and maintain sufficient funds to cover potential losses.

Q3: How is short selling regulated? A3: Regulations vary by country, but common rules include the requirement to borrow the securities before selling (known as a ’locate’ requirement) and minimum margin requirements to manage risk. Specific rules may include restrictions on when and how short selling can be initiated.

Q4: What is the difference between short selling and put options? A4: Short selling involves borrowing and selling the actual security with the hope of buying it back at a lower price. A put option, however, gives the holder the right, but not the obligation, to sell the security at a predetermined price within a specific timeframe.

Q5: Why would an investor choose to go short instead of selling call options? A5: Going short is often used by traders who believe that a particular security is significantly overvalued and will drop in price. Selling call options involves a similar belief but focuses on collecting premium income rather than capitalizing on the full decline in security price.

Related Terms§

• Going Long: Buying securities with the expectation that their value will increase.
• Short Sale: The actual transaction of selling borrowed securities in anticipation of a price decline.
• Margin Call: A broker’s demand that an investor deposit additional money or securities to cover possible losses.
• Hedge Funds: Investment funds that may employ short selling as part of their strategy for generating returns.

Online Resources§

• Investopedia: Comprehensive guide on short selling.
• SEC.gov: Official regulatory information about short selling.

Suggested Books for Further Studies§

1. “The Little Book That Still Beats the Market” by Joel Greenblatt
2. “Against the Gods: The Remarkable Story of Risk” by Peter L. Bernstein
3. “The Intelligent Investor” by Benjamin Graham
4. “Flash Boys: A Wall Street Revolt” by Michael Lewis

Fundamentals of Going Short: Investing Basics Quiz§

Thank you for exploring the concept of going short with us. Keep learning to become a more informed and strategic investor!