There was a curious debate recently on another list on how to calculate short-sale profits.
A stock going from 40 to 10 would yield 300% in gains, based on the cost basis (cover price) and sales price (short-sale price), and yet this seemed to generate some disagreement. Basically, gains are calculated as they are in taxes, with the date acquired and date sold effectively reversed from what they would be with longs. While the change in price would be -75% from 40 to 10, the profit would be 300% because the profit is the sales price minus the cost basis, and the percentage gain is always the (difference/cost basis) *100. The difference is 30, the cost basis is 10, the percentage is 300.
More than one person stated that the profit would in fact be 75 percent, confusing price change with profit, and one added that the maximum short profit for a stock shorted at 100 would always be 100 percent (if it went to 0). But this is not correct. If the stock was covered at 1 and shorted at 100, in fact, the profit would be the short sale price minus the cover price (100 - 1 = 99), divided by the cost basis (cover price of 1), times 100, or 9,900 percent. This seems like a lot, because it is a lot. An investment of 10,000 dollars, for example, would have yielded 99 times that in profit when the trade was covered. A 100 percent profit means doubling the investment, of course, not multiplying it times 99.
I ran this by an accountant, and the conclusion was the same: A stock shorted at 40 and covered at 10 would mean a percentage gain on the trade of 300 percent. Yes, the price declined by 75 percent, but the profit was 300 percent. I ran it by a broker with many years of experience, and the conclusion was the same: 300 percent. And yet the dissenters continued to say 75 percent, curiously enough. The obvious eludes them.
Discussion? |
