I finally watched The Big Short this weekend. It’s the movie that chronicles the fraud and abuse in the mortgage industry and on Wall St. that led to the Great Recession. Good movie. I think it did a good job with a very complex topic. Basically, it follows three groups of investors that see the downfall of the housing market and try to make money by betting against, or “shorting”, it. So, this month, I thought I’d write about what it means to short a stock. The following information is for educational purposes only. It should be noted that this strategy is not suitable for most investors.

(Please note that if you’ve seen The Big Short, this is slightly different from what they were doing. The bet is the same, but the process is different.)

When you buy a stock, you do so believing that the price will go up. Your bet is that the company will do well, increase in value, and you will make money. If, however, you believe that a company will not do well and will, in fact, decrease in value, you can make that bet, too. This is called shorting a stock. When you short a stock, you borrow shares of a stock that you don’t own and immediately sell them. If the stock goes down, you buy back the shares, return them to wherever you borrowed them and pocket the difference. Pretty straightforward. Well, maybe.

Shorting a stock is basically the opposite of buying a stock. Instead of buying and then selling, you sell and then buy back. But there are some things to consider. For instance, when you buy a stock, your maximum loss is the amount of your investment. I.e. you can only lose what you’ve put in. However, when you short a stock, your maximum loss, in theory, is infinite. There is no ceiling on how high a stock’s price can go.

Also, short positions tend to be trades as opposed to investments. By that I mean they tend to be short term rather than long term. Long term investors with significant time horizons will be able to hold a stock even if it dips in price. However, traders with short positions will tend to get nervous if a trade starts to go against them and may buy back to cover their short. If a stock moves sharply upwards, this may cause some shorts to cover, which will cause the price to move even higher, which may cause even more shorts to cover and so on. This is called a short squeeze.

Shorting stocks has been used by large investors for years to try to capitalize on companies they believe are overvalued or in trouble. Recently, Bill Ackman of the hedge fund Pershing Square has shorted Herbalife because he believes that the company is a multi-level marketing scheme that takes advantage of economically disadvantaged communities. He believes that the Government will eventually shut down the whole company. Whitney Tilson of Kase Capital shorted Lumber Liquidators because of the allegations of formaldehyde in their products (which proved to be correct). And it’s not just stocks. Legendary investor George Soros shorted the British pound in 1992 before it exited the European Exchange Rate Mechanism and crashed. Earning him over $1 billion.

Shorting stocks is not for everyone. In fact, in my opinion, it’s for hardly anyone. It’s a very risky strategy that probably shouldn’t be used by the majority of long term investors. Unlike buying shares of a stock, putting on a short position is not something you can do and forget about for a year. It takes constant monitoring, which probably isn’t something the average investor wants to do.

*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

 

Gavin Chinn, CFS* Financial Advisor

Check the background of this investment professional on FINRA’s BrokerCheck.

An Investment Advisor registered through CUSO Financial Services, L.P., Gavin has 22 years of experience as an advisor in the Puget Sound area.

“I believe every client is unique and deserving of a personalized financial plan that will help them reach their individual financial goals. Before I make any recommendations, I like to get to know my clients. By asking the right questions, and developing an honest, trusting relationship I can really get a sense of what’s going to work best for them.”

Gavin graduated from the University of Washington with a BA in Business Administration and started his financial career with US Bank in the Investment Department. Prior to joining Verity in 2006, he spent eight years with Piper Jaffray.

So what is Gavin’s vision for his dream retirement?

“My dream retirement would be absolutely worry free: financially, emotionally, and in every aspect of life. My finances would be in order so expenses for travel, luxuries, and gifts for the kids, grandkids, and great-grandkids would be taken care of. My kids would be financially sound, so I would be confident in their prosperity. This would give me the freedom to travel and play and do whatever it is I want to do.”

When Gavin’s not working, he enjoys spending time with friends and family, watching Husky football, and taking weekend trips around the Northwest.

Gavin is registered to transact securities business in the states of WA, OR, CA, AZ, FL, HI, ID, IL, MN, NM, NY and VA.

*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Verity Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

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