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· Posted on
August 27, 2021

What’s short selling?

While Margot Robbie explains short selling pretty well in The Big Short, here's the quicker run down.

What's the key learning?

  • There are four steps to a short sell: you borrow a share, sell it, then buy it back at a cheaper price to return it to who you borrowed it from.
  • The short-seller earns the difference between the amount they sold the share for, and what the purchased it back for.
  • It's a risky move, because it's essentially a bet that the share price of something will fall - but it could rise, and you could lose out.

While Aussie actress Margot Robbie explains short selling pretty well in The Big Short (in a bubble bath with a glass of champagne FYI), we’re gonna give you the quicker run-down.

There are four steps to a short sell.

  1. Investor borrows a share (generally from a broker)
  2. Investor sells the share (preferably at a high price), 
  3. Investor buys the share (preferably at a cheaper price) 
  4. Investor returns the share to the person they borrowed it from

The investor will make the difference between the amount they sold for the share and the amount they purchased it for.

But this is v, v risky business. It’s basically a bet that the share price of something is going to fall. If you lose the bet, and the stock you borrow rises in price, then you have to buy it at that premium price to pay it back...which means you actually lose money. Boo.

Let’s run an example - when it works:

Sally is a short investor who suspects that the share price of publicly-traded company, Slurpee Pty Ltd is unrealistically high because of a celebrity endorsement. 

Salary borrows 100 shares of Slurpee Pty Ltd and sells them at $10.00 per share. She wants to wait until the share price drops before she purchase the shares. 

The celebrity endorsement fails dismally. It barely sells any Slurpees. As a result, the share price dropped to $5.00 per share. 

Sally buys 100 shares at $5.00 to repay her broker. Sally has made $500 by short-selling Slurpee Pty Ltd.

Gamestop short squeeze

Remember the Gamestop - or Gamestonk - shenanigans in January 2021?

Short-selling hedge funds were shorting stocks in the video game retailer Gamestop. In other words, they had borrowed shares in GameStop and sold them. They were waiting for the share price to drop. But then users on a Reddit thread called WallStreetBets agreed to ‘pump’ or manipulate the share price of Gamestop - so that it kept going up and up and up.

The scary thing for the hedge funds is that the potential losses in short selling are theoretically unlimited - because a share’s price can rise infinitely. 

We know that hedge funds that had borrowed the stocks had to buy them back at the higher price in the future. And with the inflated price, that would mean they lose money. And we’re not talkin’ small cash here - we’re talkin’ US$20 billion in losses.

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