Posted at 8:00 a.m.
I still don’t understand the short-selling actions. Buy a stock by betting on its fall and make a profit? How is it possible ?
Andrew G.
Nope, ” short-selling does not translate to “short sale”.
“In French, we call it a short sale,” explains François Lacasse, Senior Wealth Manager and Portfolio Manager at Desjardins Wealth Management. “It consists of selling shares that you don’t own. »
In a way, these shares were “borrowed” from a brokerage firm.
“The person doesn’t own the shares, but they owe them to the brokerage firm,” he says. She will have to buy them back to recover. It is a form of debt to the brokerage firm and this type of transaction must be done within a margin account. »
As a down payment, the investor must provide between 30% and 100% of the value of the shares sold short, adds the manager.
Subsequently, the bold investor will seek to repay his debt by buying back the same number of shares on the market to return them to the broker.
And here is where the mystery lies.
The investor anticipates that the price of the stock will have fallen in the meantime, allowing him to buy them back at a price lower than the price at which he borrowed and sold them. The difference constitutes his profit, which he hopes will be juicy.
In the meantime, the shares are debited from his brokerage account, which is thus overdrawn, hence the term “short sale”. “We pay interest,” says the manager. It’s like borrowing the shares from the brokerage firm. »
François Lacasse gives the example of 100 Microsoft shares sold short at a price of $250 per share.
The purpose of this transaction is the opposite of that of a normal transaction, where one would like to resell them at a profit. In this case, we want to buy them back at a lower price to pocket the difference. If we sell the stock at $250 and buy it back later at $200, we have made a profit of $50 per share.
François Lacasse, Senior Wealth Manager at Desjardins Wealth Management
“That’s the way people bet: sell shares to buy them back later for less. »
Bet is the right word: the maneuver is perilous.
“The danger of this transaction is that the loss can be unlimited,” he warns.
In the case of a normal stock market transaction, the worst case scenario is when the stock acquired is no longer worth anything.
“If you invested $20,000, you lose $20,000. But the short trade is more risky. »
Let’s go back to his example.
You invest $25,000 by shorting 100 shares of Microsoft at $250. Your account is credited with $25,000, but one day you will have to return the 100 shares borrowed from the brokerage firm.
If you buy back 100 shares when they are worth $200 to return them to the firm, you pay $20,000 and thus pocket a profit of $5,000 — less interest and commissions paid into your margin account.
If, unfortunately, the price of the stock has doubled to $500 and the broker, worried, demands that you return his 100 shares, you will have to pay $50,000 to acquire them and sell them to him.
“You lose all your initial bet, because the action has risen as much as the initial value, describes François Lacasse. And if it were to triple, you owe money that you didn’t initially invest. »
And since the stock price can theoretically go up endlessly, the loss could in principle know no bounds.
“There is a floor, when you buy shares, but when you sell them, there is no ceiling to which a title can go up”, asserts the manager.
“You have to understand that this is a speculative strategy. »