Scribd
Upload
12 views8 pages

Short Selling

Short selling is a trading strategy where an investor borrows shares to sell them at the current market price, anticipating a decline in the stock's value. If the stock price falls, the investor can repurchase the shares at a lower price, returning them to the broker and profiting from the difference; however, if the price rises, the investor incurs a loss. Examples illustrate potential profits and losses based on stock price changes, emphasizing the importance of margin requirements in short selling transactions.

Uploaded by

Shaheryar Rashid
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
12 views8 pages

Short Selling

Short selling is a trading strategy where an investor borrows shares to sell them at the current market price, anticipating a decline in the stock's value. If the stock price falls, the investor can repurchase the shares at a lower price, returning them to the broker and profiting from the difference; however, if the price rises, the investor incurs a loss. Examples illustrate potential profits and losses based on stock price changes, emphasizing the importance of margin requirements in short selling transactions.

Uploaded by

Shaheryar Rashid
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 8

Short Selling

Short selling
• Short selling stocks is a strategy to use when you expect a
security’s price will decline.
• The traditional way to profit from stock trading is to “buy low
and sell high”, but you do it in reverse order when you wish
to sell short.
• Borrow shares of the security, typically from a broker.
• Sell the shares immediately at the market price.
• Repurchase the shares (hopefully at a lower price) and return them
to whoever you borrowed them from. After all this, you will pocket the
difference if the share price has fallen, but will have lost money if the
price went up.
Short selling -example
• An investor believes that Stock A, which is trading at $100 per
share, will decline when the company announces its annual
earnings in one week. Therefore, the investor borrows 100 shares
from a broker while short selling those shares to the market. So
now the investor “shorts” 100 shares of Stock A which he did not
own with hopes that the share price will decline.
• A week later, Stock A’s price falls to $90 per share after the
company announces annual earnings. The investor decides to close
the short position, so he buys back 100 shares of Stock A from the
open market at a price of $90 per share and returns those shares to
the broker; this is a buy-to-cover order. Therefore, the investor
makes a profit of $10 per share which is a total of $1,000 for the
whole transaction not including commissions and interest.
• However, if the stock price increases to $110 per share
and the investor decides to close the short position, he
will need to buy-to-cover the 100 shares from the open
market at the current price of $110 per share. The loss
for this short sale transaction will be $10 per share
which amounts to a total loss of $1000 (excluding
commissions and interest), since the stock shares were
bought back at a higher price.
Short selling- example
• Mr. Johnson believes that the stock of ABC Corp. will fall in the future. He calls
his broker and asks him to find 100 shares of ABC that he (Mr. Johnson) can
borrow for a short sale. ABC's current price is $25 per share. Mr. Johnson
receives a cash inflow of $2,500 after he sells the shares he has borrowed.
• Two weeks later, the price has indeed dropped, and shares of ABC now trade for
$20 each. Mr. Johnson buys back the shares (known as covering his short
position) for $20 each. He spends $2,000 to repurchase the shares and returns
the shares to the person he borrowed them from.
• Mr. Johnson's profit on the trade is $500 ($2,500 received from the sale of the
stock minus $2,000 paid to repurchase the stock).
• Using this same calculation, we see that if the shares had risen to $27 during his
holding period, then he would have lost $200 ($2,500 received from the sale of
the stock minus $2,700 paid to repurchase the stock).
line item initial short sale price subsequent share price
1price per share 50 30 70
proceeds from initial short sale[(1)*100
2 shares] 5000
3initial margin deposit[(0.5*(2)] 2500
4total deposit with broker 7500 7500 7500
5current cost of buying back stock 5000 3000 7000
6account equity[(4)-(5)] 2500 4500 500
7actual margin[(6)/(5)] 50% 150% 7.14%

8maintance margin >30% ok ok margin call


line item initial shortsubsequent
sale price share price
1 price per share 50 30 70
2 proceeds from initial short sale[(1)*100 shares] 5000
3 initial margin deposit[(0.5*(2)] 2500
4 total deposit with broker 7500 7500 7500
5 current cost of buyinh back stock 5000 3000 7000
6 account equity[(4)-(5)] 2500 4500 500
7 actual margin[(6)/(5)] 50% 150% 7.14%
8 maintance margin >30% ok ok margin call

You might also like