From TheStreet.com, sorry if this was already posted...
Okay, I admit it. I am living vicariously through the Amazon (Nasdaq:AMZN - news) trading. I scrutinize every tick. I watch the group rise with every take and fall with every hit. It is perhaps the most compelling flash on a pretty flashy screen. (When I first started trading at my hedge fund, I used to set my screen to the Nasdaq market and watch the bids being hit and the offers being taken or lifted on individual stocks. We never say buy or sell. With a stock like Amazon you would see offerings being taken in rapid motion or bids getting smashed with reckless intensity. It was my version of a roller coaster. I found it mesmerizing. Then one day my wife turned my machine to face her and said "do some homework. You are like a kid watching cartoons." That was that. I now have a trader who watches this stuff for me and I just keep the bid and offer on my screen. That said, I am still mesmerized, but I am a heck of a lot more productive not watching that Nasdaq show.)
And it is a total waste of time. Amazon can't be gamed anymore. It is a battle of desperate shorts and foolish longs. (The main reason why I wanted to do this piece was to talk about shorting as a way of life. I have no doubt that Amazon is an amazing success story. Its market capitalization makes it a success. In fact, if it weren't for the stock market Amazon would be a failure. It would have been out of money and kaput. Now, if it wanted to, it could go buy a profitable book business with all of that stock. Tons of people are short the stock because they reason that Amazon won't make a profit and will eventually go belly-up. They think it matters that it is not the cheapest. I never get caught up in that kind of thinking. I really don't care what happens to Amazon, the company. The Amazon I know is a piece of paper, and because of mechanical reasons pertinent to short-selling, there are not enough pieces of paper to go around.
Let's spend a few seconds on short-selling. When you buy a stock, you send in the cash and the shares get put in your name -- you can also have the shares physically transferred to you, but that is increasingly rare. The stock you bought is kept in the vault of the firm you have your custodial account at. It doesn't leave there -- it is really just an electronic book entry. When you open an account with your brokerage firm, you probably signed what is known as a hypothecation agreement. That allows your custodian firm to "lend" out your shares to someone who may need them. The reason this agreement is so important is because of short-selling. You, by having your shares hypothecated, have made a bargain with your own nemesis -- the trader who wants to sell your shares short. [It actually isn't that sinister, but if you took your shares out of the vault and put them in your cash account, they could not be lent out.] Now, I come in and I want to short Amazon, or profit from Amazon's expected decline. I sell the shares short. The buyer wants his shares. I have to get them somewhere. So I borrow them from the vault. Maybe I even borrow yours. I then hope the stock declines and I can buy it back. So, I sell 1,000 shares of Amazon short at 130. I borrow your shares and have the broker send them to the buyer. The next day Amazon drops 10 points and I buy back those 1,000 shares. I just made $10,000 profiting off your misery!!
Sounds pretty simple. It is the mirror image of buying 1,000 Amazon at 120 and selling it at 130. Now, here's the problem. This whole short-selling game works because I can borrow your shares to send out to the guy who bought the stock from me. I don't own the stock, but I have to get it somewhere. But what if I can't borrow the shares? What if I can't locate any shares of stock in the vault? Well, then, my broker calls around the Street to locate stock. But what if nobody has any to borrow? What if there is no Amazon stock that isn't already borrowed? Then I can't deliver the stock. And the brokerage house has to go into the open market and buy the stock in essence to break my trade. Wherever they buy it, I am stuck. So, to go back to the example again, I sell the stock at 130. My broker asks me for the stock because it is clearly not in my account. I then say, "hey, go borrow it from the vault." The broker comes back and says there is none to be borrowed. I then say, "sorry." He then says, "I am going to buy you in." He then goes into the open market and buys 1,000 shares at 150, because that's where it was when he learned you had no stock to deliver. You just lost $20,000!! Really bad. And perfectly legal. A fiat buy.
That, my friends, is what is going on in Amazon. There is no stock to be borrowed, but people keep shorting it. Why is there no stock to be borrowed? Because so many people are short the stock already that it is all committed to other short-sellers. They have all read the stories about how it is valued absurdly and shouldn't be as large as Barnes & Noble (NYSE:BKS - news) , etc., etc. So unless you short it and cover the same day, you run the risk of being "bought in."
Now do you understand why I say I don't give a hoot about how much Amazon loses per book? I only care that I can't find the stock to send to those who bought it from me. In other words, the fundamentals, which can play such a serious role on the long side, GET TRUMPED BY THE MECHANICS on the short side. Demand of the shares exceeds supply, so I can't play.)
I was on that conference call. At the end I thought that it was a fabulous revenue quarter but a ridiculous earnings quarter. It seemed like a race to spend money, but maybe that race by itself keeps the competition at bay. In other words, no one really has a clue. (With traditional companies that are not in the rapid growth mode, we look to see how much they earn. But with rapid growth stocks we measure growth by revenues. We don't even mind lots of spending if it will prove later on to lead to an explosion in profits once the company is built out. This concept is very hard to understand even for me. Let's take www.thestreet.com. When we started this business, we figured if we could get people to pay for circulation and get some advertising, we might be able to spend a couple of million dollars building a great journalism staff and then when we got more than 20,000 subscribers we would begin to make money. But what happens after 20,000? The business begins to get incrementally profitable. Hmmm, I thought, how about if you had 200,000 subscribers and lots of advertising? Then you could make a fortune. How do you get those kinds of numbers? You have to spend. You have to get critical mass. That costs money. That's what we are doing. That's what Amazon.com did. I can't blanch when I see Amazon go up because it is spending money, because once it has built a brand, it could make a fortune. I just don't know how much of the increase in the stock is the idea that one day it can make a fortune and how much is the inability of short-sellers to borrow the stock.)
So what happens? I miss the lay-up trade of the day, the buy of Colgate (NYSE:CL - news) (right after it reported its quarter). I just looked at the headline on Colgate, and it seemed pretty drab. But drab can make you money. A follow-up phone call, just one phone call, would have revealed a very confident Colgate that felt good about the quarter and the outlook. I could have bought some stock, and then, if I wanted to, flip it for two points, in the time it took to hit up Amazon times and sales over and over. (Opportunity costs are real costs in my business. Because I was sidetracked by the fascination of the Amazon run-up, I got distracted and did not make the everyday kind of call that I should make on Colgate. I would have discovered that Total's sales were fabulous and that the company's reported number was much more solid than I knew. I would then have anticipated a bunch of upgrades and positive comments that gapped up the stock.)
My point: We are not going to the movies. We are not at the racetrack. We are not paid to watch Amazon. It makes us no money. It is just one fabulous, unbelievably fascinating sideshow that keeps us from finding the mundane easy money that in the end allows you to beat the market. I'm taking the 'Zoner off my screen. Too much fun; not enough profit. Instead, I am going over the retailers to see who got too poleaxed by all of this sudden retail madness. Now there is something that is fascinating and can be profitable. (I tried, but the weeklong selloff in the retailers lasted, well, a week long. Now on Monday I will try to assess whether the weekend was good or bad for retail so I will know if it may be worth it to brave the wrath of the sellers.)
Back to work.
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.
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