Short (or Short Position)

  

Categories: Derivatives, Trading

See: Shorting a Put.

The act of betting that a stock will trade at a lower price in the future than the price at which it's currently trading. The process of shorting a stock requires that the shorter borrows shares from the brokerage, paying an interest cost on “the borrow,” with all kinds of covenants in place, so that if the stock goes up instead of the betted-upon down, then the brokerage, at some point, usually has the right to “cover the short,” or buy those shares in the open market, unwinding the borrow.

You sell a footballer short when you mumble something about them never making it to the NFL. Think about that, all you recruiters who picked Chad Pennington and Marc Bulger ahead of Tom Brady in the draft. Tom made it. He’s done, uh…pretty well. And eventually you had to “buy him long” when it was clear he’d be an icon. You’d have to recognize his real value to the game.

Well, the same gist hits stocks. You sell Facebook short because you think the stock is overpriced. You don't like Zuck’s politics, and the government will regulate the company because of it…or because you just think that kids who “made facebook” have migrated to competitors, or just…like the outdoors.

The process? You call your broker, explain what you want to do. She quotes you the borrow, or price at which she will loan you shares, so that you can then sell them. Like...say it’s 1 percent a month. The borrow is way more expensive than normal margin rates. And then you just go ahead and virtually sell, say, 1,000 shares of Facebook at $400 a share. If the stock goes up 30 bucks, well, guess what...you’re 30 grand in the hole. And that shows up structurally as margin encroachment. Yeah...we like the football terms. And the ticker is “FB,” after all. So if your entire account only has 100 grand in it, you’re kind of getting into the red zone soon with only 20 grand of room between you and that 50 percent margin maximum as it normally applies to retail investors.

On the other hand, if it turns out the Zuck was actually an Al Qaeda rep trying to mess with America via making its politics extreme, and all of this is discovered and he’s indicted, and half the population angrily turns away from Facebook, and the stock drops a hundred bucks…well, then you’ve notionally made a hundred grand. A thousand shares times a hundred bucks.

Why just notionally? Because a) you still have the short position. Yes, you’re in-the-money with it, but you still hold it short...and b) because you’re still paying 1 percent a month interest on the borrow to hold that short.

So how do you remove the “notionally” tag? You buy the shares. That’s called “unwinding the short.” Yep, you just go into the market and buy 1,000 shares at the 300 bucks a share it’s trading at, deliver those shares to the brokerage that loaned them to you, and close out your position to book a tidy hundred grand in profits on your short. And you celebrate...until you stop. Why stop? Because you remember that all gains from the shorting of stock are taxed at the usurious, ordinary income tax rates…meaning you don’t keep anywhere near the 100 grand of gain. If you live in a blue state, you probably keep something closer to half that amount.

And you know the old saying: buy low, sell high? Well, this one is just: sell high, buy low. And that’s the long and the, uh, short of it.

Related or Semi-related Video

Finance: How does shorting a put work?1 Views

00:00

and finance Allah shmoop How does shorting a put work

00:06

Oh okay people your shorting or selling a put option

00:11

Easy derivatives trades You may very well want to do

00:14

in real life someday so let's frame things here first

00:17

To review a put is the right to sell a

00:21

security For now just think about selling Puts on the

00:23

shares of a normal liquid publicly traded company in This

00:27

makes sense because in reality oddball names that trade only

00:30

small volumes just don't get big markets made in them

00:33

by the banks who trade in them So the spreads

00:35

are so high that trading at all in those exotic

00:38

weird derivatives makes almost no sense So when you think

00:42

normal liquid publicly traded company think shares of a volatile

00:46

name but one that's liquid like G E In the

00:48

modern era it trades a kazillion shares a day It's

00:52

very liquid Well you liked the stock when it bottomed

00:55

around seven or eight bucks a share You bought it

00:57

big 100,000 shares and then you waited Then there were

01:01

takeout Rumors that Warren Buffet and Berkshire Hathaway were going

01:04

to buy the company in a stock popped a $15

01:06

a share on that whispery rumor And at that point

01:09

you sold your long position I e the shares you

01:12

just bought like a normal human being in the marketplace

01:14

At an average cost of $7 a 52 cents U

01:18

then sold them after been doubling your money in three

01:21

years and change and you felt good about that score

01:23

Buy low sell high long term gain cheaper tax treatment

01:27

Easy But you felt that your love affair in making

01:30

money off of G E stock wasn't over You had

01:33

Mohr you know lovemaking To dio you watch longingly is

01:36

the stocks slipped back to $11 in 1/4 from a

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peak of 15 80 on buffets and Berkshires fervent public

01:43

denials that they were buying the company We're not buying

01:46

G I keep telling you people we're not buying it

01:50

Okay so in the process the company was beginning to

01:52

be perceived differently like from something that was dead to

01:56

something that was recovering albeit slowly but that had real

02:00

value So you amused But if it wasn't Berkshire and

02:03

buffet buying G it'd be someone else's someday But that

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day might be very very far away or long way

02:10

off So you feel good about the stock here at

02:12

11 bucks and change You feel good about its prospects

02:14

a long term and you're thinking maybe the stock grows

02:17

a dollar a year for a few years from here

02:20

going to 12 Boring boring Lee Generally okay not exciting

02:24

not exciting enough to buy the stock in a vanilla

02:27

basic long you know non 50 shades kind of way

02:30

Importantly you notice that in the craziest volatility of the

02:34

rumored buyout and the spike then decline in the stock

02:37

price that the derivatives market quote went nuts unquote That

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is a bunch of putting call option owners got massively

02:44

jerked around in this huge stock price change with shares

02:47

that had hovered around eight or so Bucks share for

02:50

almost a year like a dead man's pulse So then

02:52

today with the derivatives traders hugely stressed out will you

02:56

think there's a way you can take advantage of their

02:58

nervousness and you decide to execute what's called the dead

03:02

money trade That is you think that at 11 bucks

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a share G is pretty much dead money for awhile

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that it'll go down to 10 on bad market days

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and maybe walk to 12 on good days but that

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it's just gonna be me Meg for at least the

03:15

next three or 45 months maybe longer So you're going

03:19

to short or sell a put option on G Well

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in doing so you're going to sell someone else the

03:25

right to put their shares to you or to force

03:29

you to buy their shares at a given price over

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a given time period If the math makes sense for

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them to do so that is you're going to give

03:37

them the right to sell you their shares of GM

03:40

set price over a set period of time And in

03:42

return you're going to collect premium from them They think

03:47

of the premium they're going to pay you as share

03:49

or stock quote term life insurance unquote And you look

03:53

at the numbers while the trading sheet looks like this

03:56

and you think that if you just quote had Teo

03:58

unquote by a ton of Gaea 10 bucks a share

04:01

today you'd be fine with that You think the shares

04:03

traded just 10 times the dollars share that the new

04:06

CEO of Gaea signaled that they'll earn next year And

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if you had to be just a big owner of

04:10

the stock for a long period of time then fine

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You alone a bunch of Gaea cost basis of 10

04:15

bucks So you decide to anchor $10 as your strike

04:18

price in this put option That's the quote long price

04:21

unquote at which you'd be happy just buying a bunch

04:24

of G E stock But wait there's more You're going

04:27

to collect term life insurance for this privilege on this

04:30

stock The nervous Nellie derivatives trader on the other end

04:32

of your trade is offering to pay a dollar a

04:34

share such that she has the right to sell Yugi

04:37

shares for 10 bucks each meaning that she thinks there's

04:41

decent odds that the company trades down to seven or

04:43

six or five bucks a share in the very near

04:46

time period of a few months And she's happy to

04:48

pay a dollar a share for the life insurance Teo

04:51

you know make that security happen in her head If

04:53

that stock does trade to six bucks a share she

04:56

can just force you to buy it at $10 a

04:59

share So when you collect that dollar from her if

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you then had to buy the G shares at 10

05:04

bucks each well then your net cost per share would

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in fact be nine bucks and it nine bucks You

05:10

think the stock is just stupid chief and that it's

05:13

a screaming by And if you're short put trade quote

05:15

blew up unquote and G did trade down to seven

05:19

bucks a share Yes you'll have lost $2 a share

05:21

in buying it And being long then Aton of shares

05:24

at nine bucks your cost No but you still think

05:26

it gets to 15 bucks in next three years so

05:29

you'll be just fine sitting on those shares long and

05:32

you know holding them you know snugly So that's more

05:34

or less the worst case outcome saving the potential that

05:37

in fact he ends up going bankrupt and well then

05:39

you lose everything but Teo you that feels like a

05:42

huge stretch at the moment Anyway you think Nelly is

05:45

nervous for no good rational reason She only looks at

05:48

charts and technicals but you study the fundamentals of the

05:52

company and you know more than she does about how

05:54

g e is really doing operationally So you have your

05:57

$10 strike price at that price you feel great about

06:00

having to be very long stock at nine bucks with

06:02

that dollar premium you would've collect And you know that

06:05

if you want to be exposed to that term life

06:07

insurance for G for only 10 weeks instead of 20

06:10

or 25 weeks well then you could just take in

06:13

50 cents of premium and be done with it sooner

06:15

So if you did that shorter term short put trade

06:18

you'd collect 50 cents a share and then have just

06:20

roughly 50 trading days toe wait and hold your breath

06:22

And with the stock trading right now at 11 25

06:25

a share if it stays above 10 Bach's well then

06:27

the 50 cents you collected per share ends up just

06:30

being fully owned by you Justus if you were a

06:32

term life insurance company and that month the guy didn't

06:35

die the time expires Or in derivatives speak the data

06:38

decays to zero and you're done You've made 50 cents

06:41

a share for doing nothing more than taking on the

06:44

risk or liability of having to buy a load of

06:47

G stock it 10 bucks a share within those weeks

06:49

when you're you know exposed But you think GI is

06:52

dead money for longer than just a couple of months

06:54

and change You think it's dead money for 45456 months

06:58

something like that So it's march now and you decide

07:00

to sell the September 10 puts And yes that's the

07:03

nomenclature When you do any of these kinds of derivative

07:05

trades you don't give the actual date that the options

07:08

expire because by default they always expire on the third

07:11

Friday of the month So this September that expiration date

07:14

happens to be September 17th your thus exposed to G

07:18

stock through March today than April May June July August

07:23

and then by September This put option expires in Mill

07:26

just goes away and note that because you're taking so

07:28

much more time orthe ada risk you got to collect

07:32

a full dollar in premium And yes we're talking about

07:36

premium life insurance here loosely That's where it comes from

07:39

versus that very short risk timeframe of two and 1/2

07:41

months where you would have only collected in a 50

07:43

cents for guaranteeing you'd buy G for 10 bucks a

07:46

share in that time period so things tryingto long and

07:48

in two months later you're in the doldrums of summer

07:51

and G dips to nine bucks a share Well guess

07:54

what The trader on the other side can in most

07:56

cases force a conversion That is they then execute the

08:01

right to put their shares on you You then must

08:04

buy them out at 10 box and then you'd be

08:06

very long The stock I you then Oh nah Lot

08:09

of shares in practice with just a break even position

08:12

here where you'd collect your dollar a premium and the

08:14

trader on the other side of the trade would just

08:16

be unwinding her position While the early execution doesn't happen

08:20

all that often had G stock condo five or six

08:23

box or lower While then likely you'd be put those

08:25

shares way early It's noteworthy that these Air American style

08:29

options by the way not European ones American options execute

08:33

or can be converted on any day until their expiration

08:37

whereas European style options on ly convert on their expiration

08:41

date So there is essentially Mohr option or Optionality you

08:45

know kind of like Wesson ality at least that kind

08:47

of value in American options over European ones American ones

08:51

you know which you can think of as a siri's

08:53

of little one day options that have faded decay decaying

08:56

entirely each day along the way to their expiration Like

09:00

so many trading days 114 or whatever left need to

09:03

pass with the stock above 10 bucks for you to

09:05

collect your full life insurance premium there But in this

09:08

case the Stuck then bounces off its lows of nine

09:11

bucks It kisses 11 again and just remains there another

09:14

month and change when that third Friday in September finally

09:17

happens and the put option expires fully well you've collected

09:20

your dollar share it's 100% profit to you and you've

09:24

done little more than be nervous during that summer when

09:26

the stock was kissing break even to you I eat

09:29

If it was put to you a 10 box when

09:31

it was trading at nine bucks then you would've still

09:33

collected your dollar in premium and just be very long

09:36

the stock at nine bucks and note that as the

09:38

put gets closer and closer to that expiration date even

09:42

with a dead flat stock price of 11 25 day

09:44

after day after day that put option becomes gradually less

09:48

valuable like here the likely values as it goes along

09:52

the way So all this is generally good news for

09:54

you The Unnerve Assn Ellie until you get your tax

09:57

bill all gains from these type of trades even if

10:00

you had let them run over a year are tax

10:03

as ordinary income So if you live in a blue

10:06

state you pay a 40 45% tax and mohr less

10:10

split half your profits with the government And had the

10:12

stock actually taken off and gone to $20 a share

10:15

in this time period as Buffet and Gang did decide

10:18

to buy the company well then you the short put

10:21

er would have on ly collected your dollar in premium

10:23

and nothing else So just like that your sordid love

10:27

affair with G is then over But don't worry though

10:30

there are plenty of other options in the sea Hey

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