Discuss the process known as "short selling". Why would an investor take a short position in a stock? What would be the risks involved in such a strategy? Describe a method that would significantly reduce the risks, but still achieve the same objective as short selling.
Im doing some research on short selling and could use some opinions?
Sounds like homework to me. When you short a stock, you are borrowing someone elses shares. You sell those shares at the current market price, and have to buy them back later to return them. Hopefully you buy them back at a lower price than you sold them for. The risk is that stocks have an unlimited upside. You could be forced to buy them back at an extremely high price.
A safer way to bet on a stock going down is to trade options. You buy Puts. The only risk is what you initially pay for the put.
Reply:If you are long on a stock you are betting the price will go up. In turn if you are short a stock you are betting that it will go down.
In order to short a stock you actually borrow the stock then turn around and sell it at today’s price and hope the price goes down.
Why would you do that?
Well let’s say that stock A is selling at $10 a share and you think it will go down, so you short 1000 shares of stock A.
If you are right and the price goes down to $5 a share. You can then buy back the1000 shares of the stock at $5 a share. You give the broker his 1000 shares back and you keep the difference of $5000 minus a fee of course.
If you are wrong and the price goes up to $15 a share, the broker can require that you cover your position. What this means is that you have to buy the 1000 shares back at $15 a share and you pay the difference of $5000 plus the fee of course.
One way to reduce risk would be a stop loss. What this would do is put a limit on what you would allow the price of the stock get to and then automatically cover at that price.
If you put in a stop loss order for $11 it would automatically cover your short position if the stock went up to $11. This will insure that you loose no more than $1000 or 10%.
Reply:It doesnt work the same in the stock market as the futures market, but I will give you an example.
They are normally called options, in the future market you are committed. The things you look for in short saling is you want the stock to be extremely high and you think its over valued. You will sell the stock above the market price. But you dont own it. You didnt buy it you bought the option to buy it. In futures you are committed to buy.
So lets say ebay is 100 bucks. You buy stocks above market price. Say you sell Ebay at 105 dollars for 100 dollar stock. People jump on it. They take your offer, but you dont own the stock. But you see its on a down turn. It falls to 60 bucks. You have to cover what you sold. So you buy the stock at 60 dollars that you sold at 105 dollars. Because the stock was going down and you overpaid. As the stock falls you make money.
Downside, you are wrong. You sold 1000 shares of stock at 105 dollars and it goes to 150, you have to fill the order. So the stock you sold at 105 you have to purchase at 150 dollars.
Thats your short sell. You sell a stock that you expect to go down, way down. Overprice the market so they take it. If you are wrong you are screwed.
Reply:Short selling allows you to profit when a market or stock is trending down.
A safer way to play down markets is with inverse ETFs or mutual funds. They are designed to gain in value as the market moves down.
Here's wishing you strong trends!
Reply:Your talking about options.
Ok so I am not going to write a 20 page book so here goes learn quick.
Buy options Calls and Puts
Calls: you make money if stocks go up
Puts: you make money if stocks go down
Write (sell) options Calls and Puts
Calls: you make money if stock goes down
Puts: you make money if stock goes up
A written (sell) put option is the greatest risk of them all. Stock can infinitly go up (in theory).
Time value also affects the option as well as the underlaying stocks price movement. As to the strategy thing you asked about. Quit cheating off of the experienced investors here and read your text book lol. I will give you an idea though it could be used as a hedge in your above example.
Reply:well short sellers are the BEARS of the marketplace. They forcast that the stock market is going to go down. Like they say, you really CAN make money both ways.
Buying a stock outright for example, or taking a LONG position you BUY low, hope the stock price goes UP
so you BUY LOW%26gt; SELL HIGH. That's the objective
you only risk the capital you invest. You can't lose any more than that. Buying stocks is very risky.
NOW take the original risk factor or buying stocks, and triple it. That's the risk of short selling, at least. Short selling is EXTREMELY risky, because the losses are unlimited.
Ok its a bit complicated, but in essence a short seller SELLS STOCK HE DOESN'T OWN..IE he BORROWS it at a high price from his broker, and then hopes to buy it back at a low price. Now, there is nothing to say how high that stock might go.......so if the stock quadruples in value lets say...the investor might lose far more than his original investment.
So a short seller SELLS HIGH and then hopes to BUY LOW.
There is another way an investor can capitalize on declining markets rather than short selling. If the person thinks a stock is going down, and wants to limit his losses, he can BUY a PUT option. A PUT option has significantly less risk than short selling, becuase the person can only lose a defined amount of money. However, the risk is still quite high.
A person buying a PUT option hopes the price will fall.
A person buying a Call option hopes the price of the stock will go up.
Anything involving stocks is pretty risky but here is the
hierachy of risk
Buying a stock or taking a LONG position
The stock can become worthless, but this typically doesn;t happen. However there is often significant variation in price that will result in major losses. Buying stocks is risky business.
BUYING OPTIONS- buy either a put or call option
You are more likely to lose all of your money, because the option expires worthless over time
Selling or Writing Options/ or Short selling- Unlimited Risk
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