One think of interest that has not yet been discussed is the case of the < $5.00 stock. Typically a brockerage house will not allow you to short an issue once it goes under five bucks. I have yet to see a really clear explanation of why this is, although it has something to do with margin requirements. In any event, a clear explanation would be helpful. However, by way of contribution to this thread, let me point out that there are other strategies to employ when you are bearish on a stock that is currently, say, $4.00.
Before mentioning one of them, let me first point out there are basically two kinds of shorts- over extended high fliers (bubble stocks), and decaying dying companies (buzzard bait). Money can be made with each of these, but different stragtegies are involved. In any event, there are many who labor under the confusion that once a stock is "so low" it isn't worth shorting any more- this is unfortunate because they are missing out on great candidates. Train yourself to think in terms of percentages, not dollar figures. A drop from $5.00 to $4.00 is just as much of a 20% gain for a shorter as is a drop from $100 to $80; you'll get the same profit if you receive $10,000 from your short sale of 2000 shares of the "cheap" stock as you will if you receive $10,000 from your short sale of 100 shares of the "pricey" stock. [This of course ignores comissions which, depending on your broker, may or may not make a difference- in some cases you may have to pay more in comissions in the first case.]
In any event, I wander from my main point. Supposing you can't short XYZ because it is under $5.00, but you feel confident in your bearish sentiment, what can you do?
Let's assume there are options for XYZ. Now, you could simply buy puts. But the problem with options in general is that they are a "wasting asset", that is their value erodes over time (all things remaining equal) until they expire by a certain date. So the problem is that you could be correct in your bearish sentiments, and yet loose money because the drop in your target stock doesn't occur until after your puts expire. In contrast, the nice thing about shorting a stock is that time isn't against you- in general, the sucker doesn't have to tank by a certain date for you to make money. So what can you do when you can't go short, but don't want to add the further complication of not only guessing a stock's direction, but doing so by a specified date? [Note that the following will probably be understood only by those that already have a little familiarity with options.]
Try the synthetic short. A synthetic short is a position created with options that closely resembles a short position in terms of the way it functions.
In a synthetic short not only do you buy puts, but you write (i.e. sell) a corresponding number of calls at the same strike price. Let's make things very simple. XYZ trades at $5.00, you are bearish, but can't get shares to short (for whatever reason). So let's pretend here: buy 1 put (say it expires at the end of this month) with a strike of $5.00 and pay a premium of say 1/2. But also write a call with that same same strike and so recieve, say, 1/2 point in premium. Because of this balancing act, if the stock doesn't budge by the end of the month, both option contracts expire worthless, and you are even. So you just do it again, and again, and again, until your stock drops- when it does, your put will increase in value, and the call you sold will decrease (and hopefully become worthless by expiration). On the other hand, if the stock rises above $5.00 you will be in a very similar position to that in which you sell short- in other words, as the stock rises, your put will gradually decrease in value, and the call you sold will increase (bad for you)- note that if you just bought the put, and the stock continued to rise you would just be out the premium- but because you also sold the call, you have unlimited upside risk, just as with normal shorting.
Of course there are a lot of assumptions built into what I've said, and things are of course more complicated by the fact that you are paying more (potentially) in comissions, and we haven't taken into consideration deltas, time to expiry, premiums, yada yada yada. However, if you already have some familiarity with options you should be able to work out the basic idea in your head.
Hope that helps.
Still looking for that great explanation of why many brockerages won't let you short a $3.00 sotck, I am
Anaxagoras |
