May 2, 2010

‘Shorting’ Explained

Filed under: BartCop Page,Commentary,Opinion — zelator @ 1:33 pm

Having spent a good deal of time working as a consultant for our friends on Wall St.,  I have a pretty good handle on the technical ins and outs of the trading biz.  I have seen hundreds of commentaries on stories about the latest fiasco, and many of them are of the simple nature of ‘what the hell is shorting?’, or words to that effect.

So let’s get to it.  Let’s say you just want to make money on stocks the ‘obvious’ way – by buying some shares at a lower price, then selling them at a higher price.  This is what is known as a ‘long’ position; you are holding on to them in the hopes that in the ‘long’ run they will increase in value.  Let’s also say that you don’t want to pay cash – you might borrow $10,000 from me just to purchase some stocks.   If the stock value is, say ten bucks, you can buy 1000 shares of this stock for $10,000.  So you owe me $10,000 and you are now in a ‘long position’ of 1000 shares.   

OK – let’s say the stock price goes up to twenty bucks.  Now, if you want, you can sell your 1000 shares to someone for $20,000.  You owe me $10,000, so you keep the other $10,000.  That is YOUR profit.  I could profit by charging you interest on what you owed, but that just muddies the water.  Also, someone somewhere will get a chunk of your ten G’s as a commission.  If the stock DROPS in value, you lose and you have to give me some cash to make up the difference.  Pretty straightforward.

So how do you make money in a ‘short’ position?  We know that we need to hope that the value of the stock goes down, right?  So how do we make money? 

Let’s say instead of you borrowing money from me, you borrow some stock from me that I already own.  I take 1000 of my shares in this company and let you hold onto it for a little while.  At some point in time, you have to return those shares to me, regardless of the price of the shares.  If you take them and they are worth ten dollars each, it will cost you $10,000 in stock to pay me back, and neither you nor I will have lost any money.  However, if the value of the stock drops to, say, eight dollars, it will only cost you $8000 to pay me back for $10,000 worth of stock!  You have just made $2000 in a short sell.

So how does this tie in to the Goldman Sachs investigations?  Quite simply – if you have the credit, you can get a short position not just on equities, but on any security – foreign currency, bonds, or the dreaded mortgage-backed securities.  So – if you are selling bad mortgage-back securities to little old ladies and making a profit on the commission, then reaping the rewards for your short bets against the crappy securities you sold them, you are doing approximately what Goldman Sachs is accused of doing.

Remember – money doesn’t buy you happiness.  If it did, there would be no such thing as capitalism.

No Comments

No comments yet.

RSS feed for comments on this post.

Sorry, the comment form is closed at this time.

Powered by WordPress