A beginner's guide to short-selling. Part 1
For those of you inexperienced at short-selling (short virgins?), here is a brief guide on how it is done.
1. You need to have a margin agreement with your broker. This basically allows you to borrow money from your broker using stock or cash as collateral.
2. Identify a good candidate. This clearly is the hardest part. But say you find a company called Biohype which is currently trading at $50 and has 20 million shares out (market cap $1 billion). Now Biohype (BHYP), has a product (NuHair) that will cure baldness forever and is currently in phase III double-blinded placebo controlled trials in your small town. In fact, you go to church with many people in the trial.
On Sunday morning from the back pew where you always sit, you happen to notice that there are no fewer bald heads than there were six months ago when the trial started. Or worse yet, there are more.
Hmmm.... you say.
3. At the market opening on Monday morning, you call your broker and say I want to short-sell BHYP.
4. Broker asks: "How many shares?"
5. You say: "One hundred" (or as many as you want)
6. Broker says: "Hold on. I will check to see if BHYP can be borrowed" (more on borrowing below).
7. Broker comes back and says: "The borrow is good. What price?"
8. BHYP is currently trading at $50 bid $51 ask. Since your broker can never get you in middle (only kidding), you say $50.
9. Broker confirms the sale. "You sold short 100 shares of BHYP at $50. Anything else today?"
10. Your short account is credited with $5000 less commissions from your sale. (This $5000 really isn't your money, yet...)
11. Two weeks later, in the dead of night, BHYP puts out a press release stating that NuHair does not work and in fact causes baldness in a subset of patients.
12. BHYP trading is delayed at the open, but eventually opens at $2 (cash value of BHYP shares).
13. You call your broker with a big smile on your face and say you want to cover your BHYP short position.
14. Broker says: "You can buy back the 100 shares at $2"
15. You say: "Do it"
16. What has happened is you have "covered" your short position and your short account now shows $5000 - $200 = $4800. That $4800 is yours. Not bad work if you can get it.
Part II tomorrow explains the details and pitfalls. |
