Posted on 01/28/2021 2:02:21 PM PST by Kid Shelleen
Recent events have thrust the practice of selling a stock short into the spotlight. With companies like GameStop (NYSE: GME) and AMC Entertainment Holdings seeing their shares soar as the result of short squeezes, everyone's getting an education about the dynamics of short-selling and how it actually works.
In this latest short-selling controversy, many investors have been confused by the sheer level of exposure that short-sellers have to certain stocks. For instance, GameStop recently had short interest that exceeded 100% of its available shares. That left many investors completely gobsmacked -- but there's a simple explanation for how situations like the one we're currently in can come about.
(Excerpt) Read more at msn.com ...
And when you sell the PUT, you are selling someone, for a premium, the right to buy the stock from you for a certain predetermined price by a certain date. If the stock goes down in price between the date you sold the PUT and the expiration of the PUT then the buyer has no incentive to purchase the stock from you at the agreed price (which is now higher than on the open market) and you earned that premium. However, if the stock price goes up after you sell the PUT, the purchaser will call you out and execute his right to buy at the lower predetermined price and he will make a profit and you will take a loss. Your loss will be the difference in the current price (as you have to buy it at current market price, unless you already hold those shares to sell) minus the agreed price of the stock which the buyer agreed to when he bought the PUT; minus the premium he paid you for the option (PUT). Where you lose big is when you sell a naked put (meaning you are selling a stock put on stock you don’t already own) and the price skyrockets putting you at great financial risk.
As an example. I sell you a March 2021 PUT on a stock, say for example, RIOT. It is currently trading at $18.00. I do not own the stock but I sell you a naked PUT for 10 contract (1000 shares total) for a total cost of 2 dollars a share that expires in March. (You pay me $2000.00) This gives you the right to purchase 1000 shares of RIOT any time before the contract expiration date at the agreed price of $17.00. If the stock explodes to $30.00/share before the contract expires, you then buy it from me for $17,000. Your profit would be $13,000 (you bought it for $17,000 when it was worth $30,000) minus your cost for the put contract ($2000) so you just made $11,000 by risking $2,000.
My loss would be 30,000 because I sold the naked Put (remember I did not own them when I sold the PUT to you so I had to buy them at market rate the day you exercised your option) minus the amount you paid me for the PUT option, $2000; making my total loss $28,000.
Should the stock price decline from the option price the PUT will expire worthless to the buyer and I, the seller will pocket the PUT cost in this case, $2000.
It is a high risk game, much more so for the seller than the buyer as the buyer is only risking the amount of the PUT, in this case $2000 while the seller is risking a theoretically unlimited amount depending on the stock price elevation above the contract price. So in the case of Gamestock if they sold PUTS at $8.00 when the stock price was $6.00 and before expiration of the PUT the price jumped to $300/share and they got called-out they still have to sell the stocks at $8.00 but they have to buy them at $300.00, rendering them a bridge-jumping degree of financial loss.
Hmmm...
Careful... Wasn't that kind of language that JimRob was posting last week as forbidden?🙄
Yeah, what RinaseaofDs said. The articles explanation is nonsense.
Annie has sold them so she can’t “take” them back. She has to go out and buy some. They don’t have to be the same shares. When the Annies (shorts) are all trying to buy at the same time, prices rise and a feeding frenzy ensues. That is called a short squeeze.
The word is “rehypothecation.” transferring collateral from one party to the next in a long daisy-chain
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That’s pretty much which created the house of cards, so to speak, with the housing market in 2007-8 when the same mortgages were leveraged thru derivatives.
CDOs
Dan Caplinger and Motley Fool just suicided themselves.
Rehypoallocation worked for John Corzine.
According to the motley fool article, Annie didn’t sell her shares, they were borrowed from Annie by Bob, the first one doing the short.
It also says Annie has the right to get those shares back.
replace Annie with Bob in my commentary.
Call
I believe you can structure a Covered Call that acts like a put.
https://en.wikipedia.org/wiki/Covered_call
There are multiple ways to protect investments, there are books written on it.
If you want to avoid blatant manipulators you need to only trade high volume blue chips.
Pump and dump schemes are there for ages since the stock exchange appeared.
Puts and calls are a bad form of gambling in most cases.
Buddy almost had his house foreclosed by a scheme like that. Fortunately for him he sent paper checks to the mortgage company, who had sold his note to three different companies while still accepting payments.
Took a few years for him to fix.
So how much of the stick market actually exists?
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