By Sean Corey
Staff Writer
Let’s say you believe a company will have poor earnings and their stock price will decrease. Rather than simply not buying the stock, you can make money off the stock’s decline by shorting the stock. When you short a stock, your bank will lend you a number of shares of the stock. You can then immediately sell the borrowed stock and gain the proceeds from the sale. In return, you promise to return the exact number of shares that you originally borrowed back to the bank at a later point in the future. Your profit or loss will be the difference between what you originally gained from selling the shares and how much you paid to return the shares.
As an example: let’s say you think McDonald’s stock (MCD) will decrease from $100 to $80. So you decide to short sell 100 shares. That means you will immediately gain $10,000 (100 shares times $100 per share), and in turn you promise to give back 100 shares of McDonalds to the bank at a later date. If the shares fall to $80 as you planned, then you can buy 100 shares for $8,000 and return those shares to your bank and your profit is the difference, $2,000. If the stock price rises however, you will have to buy back the shares at a higher price and you will lose money.
Now the bank isn’t going to lend you the shares with no compensation. They will charge you interest on the value of the borrowed stocks. In our McDonald’s example, let’s say the bank charges 10% interest, which means you will owe $1,000 (10 percent of $10,000) for every year you keep the short position open.
Before you start short selling it is important to be aware of the risks. Unlike buying a stock, where you can only lose your initial investment since a stock price can’t go below zero, shorting a stock can cost you a theoretically infinite amount of money since there is no upper bound to stock prices.
This Week in SIMM
Long Fund: $258,909
Energy Fund: $274,300
GAINERS
Fresh Market (TFM) 6.30%
Cheniere (LNG) 5.76%
Metlife (MET) 4.50%
Capital One (COF) 4.19%
GAINERS
Fresh Market (TFM) 6.30%
Cheniere (LNG) 5.76%
Metlife (MET) 4.50%
Capital One (COF) 4.19%
Sean Corey is a member of Students in Money Management. His email is coreysm10@bonaventure.edu
