I think you’re mistaken about that. As an empirical fact, it depends. What you are missing is the mechanism where when you sell a stock short, you don’t get to withdraw the cash (for obvious reasons). The broker keeps it until you cover your short and basically pays you interest on the cash deposit. Right now in most of the first world it’s miniscule because money is very cheap, that that is not the case always or everywhere.
It is perfectly possible to short a stock, cover it at exactly the same price and end up with more money in your account.
Actually, when you short a stock, you must pay an interest rate to the person from whom you borrowed the stock. That interest rate varies from stock to stock, but is always above the risk-free rate. Thus, if you short a stock and do nothing interesting with the cash and eventually cover it at the original price, you will lose money.
If you enter into a short sale at time 0 and cover at time T, you get paid interest on your collateral or margin requirement by the lender of the asset. This is called the short rebate or (in the bond market) the repo rate. As the short seller, you’ll be required to pay the time T asset price along with lease rate, which is based on the dividends or bond coupons the asset pays out from 0 to T.
So, if no dividends/coupons are paid out, it’s theoretically possible for you to profit from selling short despite no change in the underlying asset price.
The lease rate is an interest rate (ie, based on time) in addition to the absolute minimum payment of the dividends issued. It is set by the market: there is a limited supply of shares available to be borrowed for shorting. For most stocks it is about 0.3% for institutional investors, but 5% for a tenth of stocks. The point is that this is an asymmetry with buying a stock.
Now that I look it up and see that it is 0.3%, I admit that is not so big, but I think it is larger than the repo rate. I see no reason for the lease rate to be related to inflation, so in a high inflation environment, you could make money by shorting a stock that did not change nominal price.
(Dividends are not a big deal in shorting because the price of a stock usually drops by the amount of the dividend, for obvious reasons.)
I think you’re mistaken about that. As an empirical fact, it depends. What you are missing is the mechanism where when you sell a stock short, you don’t get to withdraw the cash (for obvious reasons). The broker keeps it until you cover your short and basically pays you interest on the cash deposit. Right now in most of the first world it’s miniscule because money is very cheap, that that is not the case always or everywhere.
Maybe if you have the right connections, and the broker really trust you. The issue is suppose you short a stock, the price goes up and you can’t cover it. Someone has to assume that risk, and of course will want a risk premium for doing so.
Maybe if you have the right connections, and the broker really trust you.
It doesn’t have anything to do with connections or broker trust. It’s standard operating practice for all broker clients.
The issue is suppose you short a stock, the price goes up and you can’t cover it.
If the price goes sufficiently up, you get a margin call. If you can’t meet it, the broker buys the stock to cover using the money in your account without waiting for your consent. The broker has some risk if the stock gaps (that is, the price moves discontinuously, it jumps directly from, say, $20 to $40), but that’s part of the risk the broker normally takes.
Another thing to watch out for when shorting stocks is dividends. If you are short a stock on the ex dividend date, then you have to pay the dividend on each share that you have shorted. However, as long as you keep margin calls and dividends in mind, short selling is a good technique (and an easy one) to play a stock that you are bearish on.
And, no, you don’t need any special connections, although you typically need to request short-selling privileges on your brokerage account.
Another way to play a stock you are bearish on is buying put options. But put options are a lot harder to use effectively because (among other reasons) they become worthless on the expiration date.
You have to pay a broker to sell what you have as well :-P
A lot less.
Also, this further breaks the asymmetry between making and loosing money.
I think you’re mistaken about that. As an empirical fact, it depends. What you are missing is the mechanism where when you sell a stock short, you don’t get to withdraw the cash (for obvious reasons). The broker keeps it until you cover your short and basically pays you interest on the cash deposit. Right now in most of the first world it’s miniscule because money is very cheap, that that is not the case always or everywhere.
It is perfectly possible to short a stock, cover it at exactly the same price and end up with more money in your account.
Actually, when you short a stock, you must pay an interest rate to the person from whom you borrowed the stock. That interest rate varies from stock to stock, but is always above the risk-free rate. Thus, if you short a stock and do nothing interesting with the cash and eventually cover it at the original price, you will lose money.
If you enter into a short sale at time 0 and cover at time T, you get paid interest on your collateral or margin requirement by the lender of the asset. This is called the short rebate or (in the bond market) the repo rate. As the short seller, you’ll be required to pay the time T asset price along with lease rate, which is based on the dividends or bond coupons the asset pays out from 0 to T.
So, if no dividends/coupons are paid out, it’s theoretically possible for you to profit from selling short despite no change in the underlying asset price.
The lease rate is an interest rate (ie, based on time) in addition to the absolute minimum payment of the dividends issued. It is set by the market: there is a limited supply of shares available to be borrowed for shorting. For most stocks it is about 0.3% for institutional investors, but 5% for a tenth of stocks. The point is that this is an asymmetry with buying a stock.
Now that I look it up and see that it is 0.3%, I admit that is not so big, but I think it is larger than the repo rate. I see no reason for the lease rate to be related to inflation, so in a high inflation environment, you could make money by shorting a stock that did not change nominal price.
(Dividends are not a big deal in shorting because the price of a stock usually drops by the amount of the dividend, for obvious reasons.)
Maybe if you have the right connections, and the broker really trust you. The issue is suppose you short a stock, the price goes up and you can’t cover it. Someone has to assume that risk, and of course will want a risk premium for doing so.
It doesn’t have anything to do with connections or broker trust. It’s standard operating practice for all broker clients.
If the price goes sufficiently up, you get a margin call. If you can’t meet it, the broker buys the stock to cover using the money in your account without waiting for your consent. The broker has some risk if the stock gaps (that is, the price moves discontinuously, it jumps directly from, say, $20 to $40), but that’s part of the risk the broker normally takes.
Another thing to watch out for when shorting stocks is dividends. If you are short a stock on the ex dividend date, then you have to pay the dividend on each share that you have shorted. However, as long as you keep margin calls and dividends in mind, short selling is a good technique (and an easy one) to play a stock that you are bearish on.
And, no, you don’t need any special connections, although you typically need to request short-selling privileges on your brokerage account.
Another way to play a stock you are bearish on is buying put options. But put options are a lot harder to use effectively because (among other reasons) they become worthless on the expiration date.