You've probably heard the term short sale, and have at least
a general-- oh, what did I do with that?
Oh there it is, I scrolled down-- you probably have a
general idea that it means, to some degree, making a bet that
a stock will fall.
And there's been a lot of news lately that maybe short
sellers are to blame for a lot of the stock market crashes,
or what's happening with banks.
So I thought it would be worthwhile to at least explain
what a short sale is.
And then we could talk a little bit about whether
they're positive or negative, or they could be both.
So you are right if you think that a short sale is some type
of a bet that a stock can go down.
But how does it work?
So let's say that, I don't know, IBM-- and I don't know
where IBM is trading right now-- but let's say IBM is
right now-- the last trade was at $100.
And I'm convinced.
I've done my research, I've done my analysis, and I'm just
convinced that the stock price of IBM is going to fall.
I think IBM is going to have a horrible quarter next quarter.
That some other competitor is going to take
their business, whatever.
I'm convinced it's going to fall to $50.
This is what I think.
I think it's going to fall to $50, based on
my deep stock analysis.
And so, the general idea is that I should-- well I won't
make any value judgment right now-- but I want to know if
there's a way that I can make money off of my deep analysis.
And the way I do that is I go to my brokerage-- so let me
draw some diagrams. So this is my brokerage, this is my
broker, and this is me right here.
This is me.
I have a top hat.
Anyway, so I go to the broker and I say broker, I would like
to short IBM.
I would like-- let's just say for simplicity I want to short
one share of IBM.
So what I do is I go to the broker, and I say broker, can
I borrow a share of IBM?
And this is a little unintuitive the first time
people learn about it.
It was a little unintuitive for me the first time I
learned about the notion of borrowing a share.
But you can also view it as renting a share.
And you might say well, where's the
broker getting it from?
Well this broker's got a ton of clients.
Let me draw some of them.
His eyes were strange.
OK, so this broker has a ton of clients,
many of whom own IBM.
And they keep their shares of IBM with the broker.
So the broker always has-- let's say each of these is a
share of IBM.
And these guys are all owners of IBM.
And if ever, one day, this guy wanted to sell his share of
IBM, the broker would go out there, sell it in the market,
or maybe this guy would sell it,
depending on how it's done.
And then this would be replaced with the money, and
this would then become $100, right?
And then if IBM issues a dividend, if it says OK, all
of our shareholders will get $5.00 from a company.
And then each of these guys would get $5.00.
So they're all just shareholders in the company.
And also, just so you know, as opposed to being short the
company, they're long.
When you go long [? on a ?]
security, you're buying the security.
When you go short, as you'll see, you're borrowing the
security and selling it.
So let's see how that works.
So once again I go to my broker and I say broker, I
want to borrow a share of IBM.
And the broker says OK, well I've got all these share
sitting around here.
And they're really not doing anything.
I'll lend you this share right there.
And stick it in my account.
And I'm going to have to pay rent to borrow that share.
You can kind of view it as either interest on borrowing
the share, or you can view it as rent.
Rent is sometimes more intuitive.
Because whenever we talk about when you rent someone's
apartment, you're really kind of borrowing their apartment.
Then you can kind of view the rent as the
interest on the apartment.
Or the other way to view it, when you borrow money, the
interest is kind of rent on the money.
Anyway, I think you get the idea.
But I'll borrow this.
And you'll say hey wait, Sal, that doesn't make sense.
How can you just borrow this guy's stock?
I mean, this guy might want to sell it the next day.
And that's a good question.
If this guy wants to-- let's say I borrow his stock, it's
not sitting there anymore.
If this guy wants to sell his stock the second after I
borrow it, the broker is just going to take-- he's just
going to shuffle around the stocks a little bit.
I mean, you know stocks are-- they call it fungible, you can
replace one stock certificate with the other.
They're no different.
So then he'll say OK, I'll just give this
stock to this guy.
Whoops.
I just messed up with my pen.
I'll just give this stock to the guy who wants to sell it,
and then you would have essentially
borrowed from this guy.
And you could keep rearranging the securities so that none of
these guys ever know that their stock is borrowed.
Although you have to give permission, especially if
these guys own the stock outright.
They have to give permission to let the stock be borrowed,
and they benefit, because they get some cut, hopefully, they
get some cut of the rent, or the interest that I'm paying.
So it's beneficial to them.
And the broker can never, well it should never, really, lend
out all of the shares here.
Just so that it can keep shuffling around.
And we'll talk about what happens if you actually try to
do this with a share that you've never borrowed.
We'll do that in a future thing.
But the general idea is, you borrow one of these shares out
here, and then the broker can kind of keep shuffling around
these shares, if any of these guys really want to get rid of
their share.
And let's say I've borrowed this guy's.
Let's say I originally borrowed this guy's share.
This guy wanted to sell his share.
So what the broker does is, he takes this share, gives it to
him, and now I have officially borrowed this guy's share.
Right?
This is the share I'm borrowing now because this
one's been sold.
Now, what happens if IBM issues a dividend?
It says every one of our shareholders should get $5.00.
Well this guy's expecting a $5.00 check.
Or he expects $5.00 to be deposited in
his brokerage account.
For that to happen, I essentially have to write this
guy the $5.00 check.
So I have to make it look, or at least the broker is going
to force me to make it look like this guy
still owns the share.
So anything that this guy gets by being a shareholder of this
stock, I have to provide for him.
Anyway, so I've borrowed the stock.
Now what do I do with it?
My whole thesis here is that IBM is going to $50, so how do
I make money off of that?
So I [? set ?]
[? this ?]
trading right now at $100.
I've borrowed this share.
So I sell it.
So let's see, the first thing is I borrow one share, as I've
done there.
And now I sell it on the market.
And we said it's selling for $100.
I sell it for $100.
So I sell it to the market.
Let's say the market is out here to the left.
So I sell to the market, and I get $100.
So let's see what's happening right now.
What's my current state of affairs?
Let's say assets-- and I'll talk about margin requirements
later-- liabilities.
What do I have, what do I owe?
So now I have $100.
And what do I owe?
I owe one share of IBM.
Let's say my analysis ends up being correct,
often times it won't.
And we'll talk a little bit more about why short selling
can be extremely risky.
But let's say my analysis is correct, and a couple of days
later IBM starts trading at $50.
What I can do now is unwind my trade, or cover my short.
And the way I do this, is I have $100, right?
What I can do is, I can then just go out there and buy my
shares of IBM back, right?
So I buy one share of IBM.
And how much do I have to pay?
Do I have to pay $100?
Well no, the share of IBM stock price
has dropped to $50.
So actually, let me do that.
I'm not paying $100 out, I'm going to pay $50 out.
And I'm going to get back a share of IBM.
I'm going to get back a share of IBM, and that's what I owe.
So I'll give it back to my brokerage.
So I will go out, spend $50, get back a share, and then
give that share back to the brokerage, give it
back to that guy.
These guys never knew that anything happened.
And in the process, what happened?
I sold the shares for $100, and I bought
them back for $50.
So after unwinding this whole thing-- I used $50 of this
$100 to buy the shares back.
So how much do I have left?
I have $50 left.
And I returned the shares of IBM, so I owe no one anything.
So I made $50 off of this trade.
So traditionally in the stock market, on the long side you
want to buy low, sell high, right?
When you're short selling, you're doing the same thing,
but you're doing it in reverse.
You want to sell high and buy low.
Anyway, hopefully that gives you the general idea of the
mechanics of short selling.
In the next video I'll talk a little bit more about what--
this was a very good scenario, where what I wanted to happen
did happen.
But in the next video we'll talk about the risks of short
selling, and maybe a little bit of a discussion of whether
it really is good or bad for the markets, or for
society as a whole.
See you in the next video.