Shorting?

[ripvanwinkle]

I've been giving some thought about shorting. I just have to ask a question. I know I have to open a margin account. I know I have to "borrow" the stock.

I searched shorting and this basically sums it up. "The short seller borrows shares from the original owner, and immediately sells them on the open market to any willing buyer". The one thing I'm not clear on is who do I "borrow" the stock from? My broker? 

[2kids10horses]

Yes.  If the broker has any.  (They generally do, unless for some reason there are a lot of short positions already on the stock and others have beat you to them.  Back in the day, when Enron was going down, you couldn't short it, no one had any to lend!)

What broker are you using?  Do you trade on-line?  When you place your trade, you will see the options:  Buy, Sell, Buy to Cover, Sell to Short.

What are you thinking of shorting?  And why?

[2kids10horses]

tough,

You can limit your losses by placing a stop order (Buy to Cover) at some predetermined price or percentage.

[ripvanwinkle]

I'm just thinking right now. No hard plans on any stock yet. A while back I was thinking RIMM but I think I missed the boat on that.

[2kids10horses]

tough,

There are several ways to do it.  There are "Limit Orders" and "Stop Loss orders".  On something like this, you would enter a "stop loss order".  Examples are the best way to illustrate.

Let's sell XYZ stock short at $50, thinking the price was going to fall.  You're willing to  risk 10%.  You could enter a "Good Till Cancelled" order to Buy to Cover XYZ stock if the price of the stock reaches $55.  So, if the stock price reaches $55, an order would sent to the exchange to buy XYZ.  A "Market Order".  A market order says to buy the stock at the "offer" price on the exchange.  It's possible that during the miliseconds it takes for the order to reach the exchange, it could go up or down a few pennies, so it won't necessarily execute at $55.  But it should be close.

(There are other types of stop orders where the market would receive an order to buy at $55.  Those are called "Limit Orders".  If, as you say the market is running, if the price reaches $55 and the system triggers your Limit order to buy at $55, but the market is running, you might not get filled if the price zooms on up.  Therefore, you wouldn't place one of these type orders as a "Stop Loss".)

Now, let's say the strategy is working.  Our friend rip sells XYZ at $50, and since he's got a crystal ball, the price drops like a rock.  It goes down to $40.  He's got a profit!  He would like to protect that profit, but he thinks XYZ is a real dog, and might fall even farther.  He could set a GTC (good till cancelled) order to issue a stop loss at 10% above the lowest price that occurs.  It's set immediately at $44.  (10% over $40).  If the price goes up to $43.99, nothing happens.  If it stays around, $40, nothing happens.  If the price drops below $40, the stop is recalculated.  Let's say it goes down to $38.  10% of $38 is $3.80, so the stop would be recalculated to be $41.80 ($38 + $3.80).  So, as the stock drops, the stop drops, too.  Until there is a move back up equal to 10% of the lowest price acheived.  Again, when the stop price is acheived, it becomes a market order at that time. 

Virtually all short sellers use stops like this to 1) protect profits, and 2) prevent the "unlimited loss" you referred to.

The "Cushion" can be set at whatever % you're comfortable with.  I used 10% because it's easy to calculate in my head.  It could be whatever you want.

And, you can use "stop orders" when buying stock long, too.  Works the same way.

[2kids10horses]

Shorted stocks?  Sure!  How do you think I know so much about it?

Short squeeze...

As stated above, when you short a stock, it is a borrowed stock, that must be returned. Which means that eventually, it has to be bought back.  Now, as I stated, most people who short stock protect themselves by setting Stop Loss orders to buy the stock back if the price starts to move against them.  So, what happens is as the price falls on a stock that many traders are shorting, there are Buy orders building up, too.  Those are set above the current price, but would get triggered as new "Market Orders" if the price of the stock were to rise. 

These automatic stop loss orders are just waiting for a trigger to set them off.  Eventually, some of the short sellers feel that the price has dropped as low as it will go, and they just buy the stock back to reap their profits.  (They would cancel their GTC Stop Loss orders.)  This action stops the decline in the stock price, and other traders start to do the same, which eventually causes the price of the stock to rise.  Then, KABAM!!!  The chain of protective stop loss orders that other traders have set click in with market BUY orders and the price of the stock explodes upwards.  It can happen very fast.  This is also called "taking out the stops".

Many traders look for stocks where there are large short positions hoping to buy in and set off a "short squeeze".

[2kids10horses]

Sure!

As I said, once the trigger price is hit or surpassed the protective order becomes a "Market" order.  So, if you had an Stop Loss at $38.50, and the stock hits that price, your order would be placed.  It might get filled above or below $38.50, but it wouldn't far off that.  Unless the stock is very thinly traded. 

[Deleted]

Both SELLING SHORT (Shorting) and OPTIONS are more Sophisticated Money Managment & Investing Techniques. And Yes, both carry higher risk than just flat out buying an ETF, Mutual Fund or Stock.

HOWEVER, the idea posed that COVERED Options are as Risky as Short Selling, is not fair or Factually valid. In Fact, Truth and Reality COVERED Options are yes Riskier than just playing "vanillia" with Stocks, ETFs or Mutual Funds, But far LESS RISKY than Short Selling.
The Reason for this is that the COVERED OPTIONS, are COVERED. This Means that for a PUT it would be CASH SECURED if you SOLD TO OPEN (You would have to have the cash to pay for the Underlying Stock if you got Assigned {Got "PUT"}, & That Cash is FROZEN for as long as that PUT is Open) - For A CALL that You SOLD TO OPEN, you are REQUIRED to have an amount of the Underlying Stock Equal to the Number of Shares you would have to Sell if you were "CALLED".
If One SELLS TO OPEN a CASH SECURED PUT - The Risk is that you could get assigned (have to buy the Stock @ the Strike chosen). The Potential Loss is Limited to the Cost if assigned and the resultant chance the Stock then Vaporizes (Think - ENRON, BEAR STERNS).
Depending on what you were trying to do with a play like this the potential benefits are -
(A) You SOLD TO OPEN CASH SECURED to try and make some extra Cash -
If the Underlying Stock Price goes up the PUT price goes down - You Can BUY TO CLOSE at the Cheaper Price - This is a WIN, so long as you can make more than the cost of the Trade Fees both ways.
If the PUT Contract EXPIRES worthless (Stock is above the Strike price by more than $0.01 on the Expiration Date) - You book a Profit, so long as the amount you Received was more than the Cost of the Trade Fee In. You Incur no Fee on the "Out" in this case, and you have no more Liability to the Contract. The Money You Received for the Play (minus the Fee In) is yours, pure Profit. - This is a Win.
(B) You SOLD TO OPEN CASH SECURED to try and Buy the Underlying Stock at a Cheaper price -
If the Underlying Stock Price Falls and you get Assigned (Get "PUT") You get to Buy the Stock at the Cheaper Price and you get "Comped", Because and Due to The I.R.S. Regulations which state in this case you "Reduce your basis in the stock you buy by the amount you received for the put" - Which then means you Actually got the Stock for less than potentially where it is trading, and you Spent less money to Buy the Stock. - This is a win.
If the PUT Contract EXPIRES worthless (Stock is above the Strike price by more than $0.01 on the Expiration Date) - You book a Profit, so long as the amount you Received was more than the Cost of the Trade Fee In. You Incur no Fee on the "Out" in this case, and you have no more Liability to the Contract. The Money You Received for the Play (minus the Fee In) is yours, pure Profit. - This is a Win.
The Scarey Part in Either of these is that IF the Underlying Stock Prices Falls, The Value of the PUT will go up - And As any PUT SOLD TO OPEN is reflected as a NEGATIVE Value in your account the "Loss" can get to looking Nasty.

For COVERED CALLS; all the Aforementioned holds true - with one extra "twist": If you Get CALLED, you have Limited your upside gain and Potentially missed out on a Killer upside gain.

NOW FOR UNCOVERED OPTIONS, HOWEVER THE RISKS ARE AS GREAT IF NOT GREATER THAN SELLING SHORT.

Aside from these things there are 2 other things that Folks need to Know, Understand and be Acutely aware of (1) The I.R.S. Regulations as to how either of these (Selling Short or Using OPTIONS) are accounted and Recorded on Both Sides of the Equation {Your Account and Tax Wise} - If You aren't you can inadvertantly "hang" yourself. & (2) The Maintanence Requirements and Your Maintanence Excess; Again, If You aren't you can inadvertantly "hang" yourself.

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As to this article - www.investopedia.com/articles/optioninvestor/09/bear-vertical-put-spread.asp#axzz2JrwaFHtL

If you Already own the Stock @ a lower Price and you BUY A PUT (CASH SECURED or UNCOVERED) at a higher Price and you Chose to Exercise it Because the Stock Price Fell - You would NOT be Selling Short. You would in Fact just be Selling your Stock at a Higher Price.
That is because in FACT When you BUY a PUT it gives you the Right To SELL at a Set Price, No Matter where the Stock is actually Trading.

If You Don't Own The Stock and You SELL a PUT (CASH SECURED or UNCOVERED), You Are SELLING SOMEONE ELSE the Right To Force You To Buy the Stock at a Set Price, No Matter where the Stock is actually trading.

AND if you SELL a Lower Priced PUT, While at the Same Time BUYING a Higher Priced PUT; the Play is Either a HEDGE or ARBITRAGE play: Depending on what you intend to do, and whether or not You Own the Underlying Stock BEFORE you Engage in this Play. AND depending on that then the Play Could Be A Synthetic Short Sale.
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As I said these SELLING SHORT or using OPTIONS are more Sophisticated Money Managment & Investing Techniques. They should not be undertaken or used without Careful Consideration of the Substaintial Risks Involved and a Very good understanding of how they work.

In Reality (IMHO & as much as I don't really like ETFs) the Average Investor would likely be better off if they wanted to "Go Short", By Using an INVERSE ETF {and Preferably a plain "Vanillia" one not a 2x, 3x one}

[Deleted]

 Buying a PUT OPTION is a HEDGE play, akin to insurance. The Nice thing with them is that if the Stock Falls once you have done one, you have a choice as to how to proceed. You can either Exercse the PUT and force someone else to "Eat" the Higher Cost - Or - You Can Sell the PUT for more than you bought it for. The Downside is that the Stock could run away to the upside and you could lose the amount you Spent to buy the PUT - But even so the cost is contained.

Selling a Covered Call is also a HEDGE play in the sense that once you do it If you get Called you are out - if the Stock then rolls over and drops you are out near the Top, no fuss no mess. The Downside is that you could get run over, missing out on a sizable upside move - missing out on  profit.
Here again the Cost is Contained, but so are the Potential Profits.

[Deleted]

Thinking Conservatively and proceeding along that frame of mind does not make anyone contemptibly fainthearted (Craven). Rather a Healthy Respect for Risk is smart and Respectable.

[2kids10horses]

All that aside,  short selling is a strategy that can work for traders.  They'll pick a basket of, say, 10 stocks that they think are likely to fall in price.  Short them all, and set tight stops.  If one of the 10 drops a good bit, they're happy.  The other 9 might make small profits, or small losses... hopefully they'll offset each other.  But they hope to make a big chunk on one of the ten.

It's a strategy.

The key is knowing how (and when) to initiate the trade(s).

DI likes to sell PUTs.  That's his strategy.

Myself, I go long and short the NASDAQ100 market using ETFs.  On a small part of my portfolio only.  90% of my stock portfolio is invested in Dividend payers.  I trade using leveraged ETFs with the other 10%.  These days, with the long and short ETFs, it's easy to try to ride the waves.  You don't even have to have a margin account.  (I do, but I don't use margin.)  You do have to know what you're doing, and have a system that you can backtest to prove that it works in the long run.  Not every trade is a winner.

[Deleted]

Feb 3, 2013 14:40:49 GMT -5 @toughtimes said:

The problem with shorting is that your potential losses are unlimited.  If you want to try something like this, wouldn't it make sense to play with options first?  They are dangerous enough.  And I am talking, covered, not naked, positions.

Brushing aside the Posed question as to Options as a way to Run A Short Sale does not remove the validity of the posed Question.
Attempting to Brush off the Validity of the Answer to that question due to the Person who Posted it, or the Strategy they pursue in the area of Options does not remove the validity of the posted answer to the Posed question.
There was no attempt to Denigrate the Strategy of Selling Short. nor was there any attempt to Promote Selling PUT Options Covered or UnCovered.

Rather, the extensive response was (A) Meant to highlight the fact that Either Selling Short or Doing OPTIONs, was and is in fact a More Sophisticated Money Management and Investing endeavour; & (B) Highlight some of the Risks and Drawbacks (as well as some potential benefits) Inheirent to OPTIONs specifically, to try and answer the posed question relating to the inquiry to that end as it relates and related to the Original question and discussion from which the Specific question arose.

Either way; Selling Short or Doing Options is Far more Risky than Just Buying or Selling Stocks, ETFs or Mutual Funds. And If We are all Being Honest and Adult. these are just not Financial Vehicles that Newer Investors should just run off and try to do. One should have a Fair bit of Experience and Knowledge of the Risks and how they work before Anyone should dare attempt Either of them.

If More Experienced and Knowledgeable Investors Can't or Won't speak up to that and other things like that, then all More Experienced and Knowledgeable Investors do is further breed and promote an environment and culture in which Newer, Smaller Investors continue to get lead astray, taken advantage of and Run clean over.

[2kids10horses]

DI, it is true that shorting stock is not a good way for a beginning investor to start.  I am no way advocating that it is.

Toughtimes made some comments about the risk of loss is unlimited when shorting stocks, and it is, but i mentioned that it's possible to mitigate the risk.

Dividends aside, you make money in stocks by Buying Low, and Selling High.

The traditional way is buy first, and wait for the stock to rise, then sell.

But, it's certainly possible to sell first, then buy later.  (You do have to pay interest on the amount you sold for.  That's why its a margin account.)

Hopefully, the OP will read thru this thread and learn that he needs to have a complete strategy in place.

[ripvanwinkle]

Oh my!! I didn't think that much strategy was required .  It sounded simple on the surface. I think I'll hold off and rethink this. I've bought many stocks with a limit or GTC. That's easy.

[Deleted]

Rip - Yes, SELLING SHORT or Doing OPTIONS - requires a lot of Strategy. But if done right, the Rewards can be Great, Conversely done wrong the Losses can be devastating.

MOD E once gave me 2 bits of Advice they were - (1) If you are considering doing something that you aren't sure of or don't quite understand, Ask someone who does. & (2) After you get more information following your First Instinct is usually the Safest way to go.
These 2 bits of advice have proven their worth many times over.