Sometimes, being short isn’t so bad

Fernando J. Saballos, Contributor

This year’s Oscar winner for best adapted screenplay, “The Big Short,” chronicles the multiple causes of the 2008 financial crisis. While millions of Americans lost money, there were a select few who actually made money on the loss. The anti-heroes of “The Big Short” utilized a relativity less-discussed investment strategy: the short.  

When you purchase a stock, you want the value to increase so that when it comes time to sell, you make a profit. But what if you wanted the exact opposite to happen? What if you wanted to invest in Blockbuster during its swan-song in order to profit from its downfall? The beauty of investment is that numerous options exist for the investor to find a way to make a gain. That’s right: you can essentially bet against any stock by selling it short.  

To begin, you must have a margin account with your brokerage. Margin is just another way to say borrowing. When you short-sell a stock, your broker will lend the stock to you. The stock will come from the brokerage’s own inventory, from another one of the firm’s customers, or from another brokerage firm. This might sound confusing, so let’s put it into context.

Company XYZ is currently valued at $100, but you’ve read up on it and believe this price is inflated. By shorting XYZ, your broker will lend you the stock on the margin account. The shares are sold out to the market and the proceeds are credited to your account. You are hosting $100 shares of XYZ. Now it’s a waiting game until you end the party to capitalize on your short. Your projections were correct and it has plummeted to $75. To close out your position, known as covering, you buy back those shares that were sold to the market, and you return them to your broker. Now you only have to return $75 worth of the $100 that your broker lent you, so there is a $25 profit per share.

A short can be held for any amount of time, though it can be costly and counterproductive because interest is charged on margin accounts. On occasion, the broker will need the stock back due to a low supply and will call away the shares from the shareholder. In addition, because you do not own the stock you’re short-selling, you must pay your lender any dividends declared during the period.
As always, there is risk. If the price continues to rise, you’re at a loss when you buy back the stock. So, the question might be: when do you short?  Just like with stock purchases, stock shorting should have the same considerations, just from the opposite side of the spectrum.  Short selling can be an effective investment strategy to weed out the weak in our ever-evolving society of needs and wants. How many people are lining up to go to Barnes and Noble to buy their books when Amazon is readily available? How do retail sales compare during a slow season as opposed to the holidays?  Just ask the guys from “The Big Short” how they felt about the opportunity to utilize this type of investment.