When you short a stock, you borrow stocks at today’s price to sell, with the promise you will return those stocks by a given time frame, most often 30 days.
For example a hedge fund manager, using his clients money or pension funds puts down enough capital to borrow a million bucks worth of wxyz. He thinks it will drop in value over the next 30 days by half. If it does, he buys a half a million dollars worth and pockets a half a million.
He is not actually selling stocks but the promise to deliver stocks in the future.
Say he is a real scumbbag and controls tens of millions of bucks. He starts to sell short tons of stock of a small company to create a panic by selling tons of that stock, lowering its value. It becomes a self fulfilling prophecy, as people panic and he destroys the company’s value and moves on to prey on another.
In this case they have sold short more stock than exists and others are supporting its value by buying it up mitigating the panic and even raising the price. The game gets played till the hedge fund hits its call date and they suddenly have to buy all that stock back from a market that did not drop. All that buying pressure will drive that stock through the roof as they MUST buy it at any price. And its hard to buy anything beyond 100% of it.
So the extra stock must be paid for at that days market price, and the difference between what they borrowed it at and that days price for that 100 percent stock.
It could easily bankrupt them, especially as they most likely are betting options with high multiplied margins.
What you buy at 100 bucks in an option can be 40 times multiplied on settling. You are putting in a down payment to rent stock to sell at 1 40th the price.. You can end up owing tens of thousands on a hundred buck buy in. Because you don’t put down the full price, you put in a fraction of the money to secure the bet.
Say your 100 buck bet is settled at 110 bucks because the price shifted 10 bucks the wrong way. You get a call from the broker on the phone that you must immediately deposit 40 times ten bucks minus the 100 bucks original buy in, or 3900 bucks to cover your option.
Scale that up to a million buck short going south to a 39,000,000 dollar margin phone call.
Margins can be your best friend, or your executioner.
Bankers are not merciful.
I am sure others can give you a much better explanation, but this can hold you over till they get here.
That is the best explanation of shorting I have read. I think I finally understand it. THANKS!
“Say he is a real scumbbag and controls tens of millions of bucks. He starts to sell short tons of stock of a small company to create a panic by selling tons of that stock, lowering its value. It becomes a self fulfilling prophecy, as people panic and he destroys the company’s value and moves on to prey on another.”
What’s funny is the definition of “scumbag”. Its ok if you’re a hedge fund manager but not if you’re a group of little guys? Hypocrisy at its finest.