Introdution to Short Selling

DISCLAIMER: MUST READ:

DISCLAIMER: MUST READ STAT seminars are for educational and entertainment purposes only STAT does not encourage trading with real money – any mention of strategies, trades, and contract symbols strictly refer to simulation trading, to the members that choose to participate in our Student Trading Lab We do not dispense financial advice; do not construe any words said as financial advice We do not guarantee to be 100% accurate Always do your own due diligence Consult a professional financial advisor If you do not acknowledge this disclaimer, we must kindly ask you to leave.

Introduction to Short Selling: The Dark Art of Trading:

Introduction to Short Selling: The Dark Art of Trading Hosted by: Speculative Trading & Arbitrage Team (STAT)

Introduction: Short Selling:

Introduction: Short Selling Most people don’t understand it, have no clue how it works. You will always fear what you do not understand. The market is buyers and sellers, bull vs. bears – you have to figure out both sides. How can it help me, even if I never (or rarely) short? Understanding the process will help you understand how the market actually works “physically” i.e. market microstructure Perspective: understanding the psychology behind short squeezes can allow you to profit long Use short-interest as a red flag when doing preliminary screens for long-term investment choices More awareness on some of the hot topics of Wall Street – subsequently, you become a lot more CYNICAL  but more RISK-AWARE! 

The Long Story:

The Long Story The Story of the Stock Market since the dawn of time: Everyone wants to find the next big thing. The next Starbucks, the next Apple, the next Wal-Mart… In general, Wall Street and Big $ Institutions drive the market. They are looking for earnings growth. Traders try to anticipate what the institutions do. They try to chase the Big $. That’s the concept of a stock market trader. Consequence? Earnings manipulation, day trading momentum, stock pumping (upgrades), hype & rumors, bid-side support, lots of BS

The Long Story, Pt. II:

The Long Story, Pt. II Attitude of the U.S. population: the stock market will go up in the long-run. Behavior: passive buy & hold investing becoming more popular last 20 years Buy and holders (some) ignore interest rates, returns of alternative assets, historical valuations, their entry price, etc. NOTE: this is different than “timing the market”. Consequently? Pricing inefficiencies tend to be on the side of overvaluation , rather than undervaluation in both time horizon and quantity of stocks

What is short selling?:

What is short selling? The selling of a security that the seller does not own Shorted stock is usually borrowed – and there is a finite amount depending on the stock float Derivatives do not have the same borrowing constraints, easier Selling non-borrowed securities is called “naked” short selling (sometimes legal i.e. market making, sometimes not) The seller is obligated to ‘buy back’ (cover) the security at a future date To achieve a profit , the seller must purchase the security at a lower price than the price at which he sold short If the seller purchases the security at a higher price, then he will realize a loss on that transaction Retail accounts must be MARGINABLE to short sell

Mechanics of a Shorted Stock:

Mechanics of a Shorted Stock

What’s the risk?:

What’s the risk? Markets go up over time Losses can be “infinite” (no upper boundary) Have to pay interest on stock borrow Must constantly maintain margin requirements Forced buy-in from broker due to stock borrow shortage SHORT SQUEEEEEEEEEEEEEZE!!!!! The fastest (intraday) price advances are almost always driven by short-squeezes – good buying opp?

Slide 9:

Overvalued? GTFO!

When to Short (Strategy):

When to Short (Strategy) Typically the same reasons to buy a stock, except the exact opposite Stock is technically overbought Stock is down trending to new low’s Negative events – bad earnings, lawsuit, drug results Pairs trading: make money off stock selection rather than market timing; 1 good (long), 1 bad (short) Forensic accounting & fraud – e.g. Jim Chanos , Enron Accounting irregularities – e.g. David Einhorn and Allied Capital (ALD) Macroeconomic events – e.g. Jim Rogers and Citigroup (C) Overvalued – be careful!! Not a good reason by itself

The Short Story, Pt. I:

The Short Story, Pt. I Fear and panic are most powerful than greed and euphoria. Commonly stated that price declines are 3x faster than price climbs

The Short Story, Pt. II:

The Short Story, Pt. II There is no drama in the stock market without short sellers! Those damn shorts are always bashing! The best Long v. Short battles of 2010: NetFlix (NFLX) vs. Whitney Tilson Chinese reverse-takeovers or RTO’s – MANY!!! Orient Paper (ONP) & RINO International Corp. (RINO) vs. Muddy Waters Silver vs. JP Morgan Education stocks vs. Steve Eisman – “next bubble” Coastal Pacific Mining Corp (CPMCF) vs. Seaboard Securities Has nothing to do with fundamentals – just a game. Staring contest. Rare Earth metals vs. the World InfoLogix (IFLG) vs. me …. 2008 ‘SSOY’ was Volkswagen, 2009 ‘SSOY’ was AIG. 2011??

Hypothetical scenario:

Hypothetical scenario Joe Investor wants to find growth stocks at bargain prices to invest in for above- avg returns He goes to Google Finance and screens for small-cap stocks with low P/E’s…… What are the stocks that show up on his screen?

Pros and Cons of Short-Selling:

Pros and Cons of Short-Selling Price discovery Liquidity Financial incentive for fundamental traders to uncover fraud or irregularities Can be “abused” Not popular

Conclusion:

Conclusion What to think about… Market makers Supply & demand Float structure – low float stocks, neglected stocks Which side has more risk? Market structure – uptick rule, $2.50 rule, Reg-SHO