Short Selling





Kerry Back

Short Sales

  • It is possible to sell before you buy.

  • You need to borrow the asset the want to sell and return it later.

  • This is called selling short or going short or shorting.

  • Long = own something (asset)

  • Short = owe something (liability)

Example

  • Borrow and sell 100 shares of ABC, which is trading at $60
  • ABC drops to $40 and you buy back and return the shares (cover the short).
  • You bought at $40 and sold at $60, so you made $20 per share.
  • Risk is that ABC \(\uparrow\) and you have to buy back at more than $60

Relative performance

Sometimes short to bet on relative performance.


Example: optimistic that Chevron will do well among oil companies, but not sure what price of oil will do.

Strategy: buy CVX and short XOM or oil company index.

Example

Invest $10,000. Buy $10,000 of CVX and short $10,000 of XOM.


Assets Liabilities
CVX 10,000 XOM 10,000
Cash 10,000
Equity
10,000

Suppose CVX \(\uparrow\) 30%, XOM \(\uparrow\) 10%


Assets Liabilities
CVX 13,000 XOM 11,000
Cash 10,000
Equity
12,000


You make the difference in returns on $10,000.

Stock borrowing fee

  • Have to pay stock borrowing fee (usually small).
  • Higher for hard to borrow stocks.
  • Lending stocks for shorts is a regular business for mutual funds and the like.

Margin Requirements

  • Suppose you have a $100,000 portfolio and you want to add long-short bets like the CVX-XOM example.
  • You can add $50,000 long and $50,000 short.
  • Fed Reg T: sum of long and short positions cannot exceed twice your equity, when the positions are put on.
  • Reg T is for initial margin. Maintenance margin is up to your broker.
  • This is a 150/50 portfolio (150% long and 50% short).

Dividends and interest

  • You have to pay the lender dividends paid by the stock.
  • Cash proceeds from a short sale are held as collateral.
  • How much interest you get on the cash collateral depends on your broker. Shop around.