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.
Short Selling Kerry Back