Discussion
An institution owns £10 mil of shares in a company.
Mr X wants to short the market, and drive the share price down.
So he borrows the shares from that institution.
Why would that institution want those shares in that company that they have lent to Mr X to lose value.
I don't understand short selling , please explain to me the mechanics.
Mr X wants to short the market, and drive the share price down.
So he borrows the shares from that institution.
Why would that institution want those shares in that company that they have lent to Mr X to lose value.
I don't understand short selling , please explain to me the mechanics.
one of my favourite short selling incidents:
https://www.theregister.co.uk/2006/12/13/ubs_logic...
and for balance:
https://www.reuters.com/article/us-ubs-shortsales-...
https://www.theregister.co.uk/2006/12/13/ubs_logic...
and for balance:
https://www.reuters.com/article/us-ubs-shortsales-...
Basically because Mr X has to pay to borrow the shares. Often those lending don't have a view on the direction of the shares per se. Imagine for example you are a big fund manager selling a FTSE100 tracker. You own all of the stocks in the index (more of less). You have to own, say, Shell, so if someone is happy to pay you to borrow the Shell stock you have to own, while promising to return it to you, you make a small amount of money which either means you make more money than you would by just holding the stock, or you can keep you management expense ratio down, or both.
Does that help?
Does that help?
avinalarf said:
An institution owns £10 mil of shares in a company.
Mr X wants to short the market, and drive the share price down.
So he borrows the shares from that institution.
Why would that institution want those shares in that company that they have lent to Mr X to lose value.
I don't understand short selling , please explain to me the mechanics.
The institution doesn't want the shares to lose money. My owning those shares or being 'long' on the stock they are effectively betting that the price will rise.Mr X wants to short the market, and drive the share price down.
So he borrows the shares from that institution.
Why would that institution want those shares in that company that they have lent to Mr X to lose value.
I don't understand short selling , please explain to me the mechanics.
The short seller is betting the other way.
If the price goes up the institution makes money, if it goes down the short seller does.
Short selling is also used to hedge long positions.
I'm not sure what you mean by drive the price down, someone shorting a stock alone should not cause the price to fall.
Pension fund takes a holding with a long term view. They aren’t concerned with short term general volatility. Shorters are generally short term in their horizon whether aiming to hedge a particular risk, remove a particular risk or make absolute returns.
Long term holders can then increase their yield by lending out lines of stock.
Also, the beneficial owner typically holds via a custodian and it is the custodian that runs the lending side. The beneficial owner often waves their rights under this situation and takes a flat fee from the custodian and the custodian aims to make back that fee plus profit through lending.
In a normal, balanced situation both benefit each other. It is also an extremely important mechanism for maintaining a healthy market. You only need to look at the dodgy small cap end where there is no real lending to see unhealthy volatility and manipulation etc.
Every so often there is an imbalance. I’m guessing it’s the Tesla situation that may have given rise to the question? In these situations the Board and some shareholders can become emotional and see shorting as damaging and try to take action to have lenders call in or cease lending or attempt to manipulate the open market to scare or spike short positions out.
Long term holders can then increase their yield by lending out lines of stock.
Also, the beneficial owner typically holds via a custodian and it is the custodian that runs the lending side. The beneficial owner often waves their rights under this situation and takes a flat fee from the custodian and the custodian aims to make back that fee plus profit through lending.
In a normal, balanced situation both benefit each other. It is also an extremely important mechanism for maintaining a healthy market. You only need to look at the dodgy small cap end where there is no real lending to see unhealthy volatility and manipulation etc.
Every so often there is an imbalance. I’m guessing it’s the Tesla situation that may have given rise to the question? In these situations the Board and some shareholders can become emotional and see shorting as damaging and try to take action to have lenders call in or cease lending or attempt to manipulate the open market to scare or spike short positions out.
boxedin said:
one of my favourite short selling incidents:
https://www.theregister.co.uk/2006/12/13/ubs_logic...
and for balance:
https://www.reuters.com/article/us-ubs-shortsales-...
The Porsche/VW shorting incident is by far my favourite. Total genius by those involved on the right side of it.https://www.theregister.co.uk/2006/12/13/ubs_logic...
and for balance:
https://www.reuters.com/article/us-ubs-shortsales-...
williaa68 said:
Basically because Mr X has to pay to borrow the shares. Often those lending don't have a view on the direction of the shares per se. Imagine for example you are a big fund manager selling a FTSE100 tracker. You own all of the stocks in the index (more of less). You have to own, say, Shell, so if someone is happy to pay you to borrow the Shell stock you have to own, while promising to return it to you, you make a small amount of money which either means you make more money than you would by just holding the stock, or you can keep you management expense ratio down, or both.
Does that help?
It helps,Does that help?
What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
avinalarf said:
It helps,
What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
If the FM thought the price would fall then he would exit the position. He believes the price will rise over his chosen time horizon. The fact that a shorter thinks it might fall is of no importance. The fact that this person, who is wrong, wishes to pay you some money is what is relevant. What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
For example, Berkshire Hathaway probably lends out big lines of its long term holdings and makes a good return from doing so. The shorters who pay BH May also make a capital return but it doesn’t have any impact on BH. So in essence, BH makes more money by lending than it would by not.
avinalarf said:
It helps,
What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
You're not missing much, aside from the fact that markets are made up of different opinions. What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
I think market is going up, so buy some shares.
You think market is going down, so pay me some money to borrow them for a while.
The market does what it does. Maybe up, maybe down.
After a while you return the shares to me, irrespective of what the price has done.
The fact you think its going down doesnt matter to me, my opinion is that its a good share to own, and that if you're going to pay me to borrow them its just more money in my bank.
I only crystalise a loss if I sell the shares at a lower point than I bought them at. If they go down in the 2 months you have borrowed them, and then go back up, it doesnt matter. To me its just a small paper loss which was never realised.
Thanks guys ....I'm going to think about your replies.
So if the shorter is successful and the share do fall.
1) what does the lender get out of it, apart from the small premium he gets from the shorter.
2) You still haven't explained how the lender manages the loss.
That is ....if he spent £10mil buying the shares and they tank to 500K he can he be happy about that ?
Surely if the FM sat on the shares and dealt in the market ,as and when ,he'd be better off.
If the FM thought those company shares were overvalued why not sell them himself ?
As I see it on a different angle....and I'm not avinalarf.
Company X is in trouble but possibly viable in the long term.
Then their shares get shorted and they go kaput.
Lots of folks loose their jobs and a viable company goes to the wall.
Isn't this the unacceptable face of capitalism ?
So if the shorter is successful and the share do fall.
1) what does the lender get out of it, apart from the small premium he gets from the shorter.
2) You still haven't explained how the lender manages the loss.
That is ....if he spent £10mil buying the shares and they tank to 500K he can he be happy about that ?
Surely if the FM sat on the shares and dealt in the market ,as and when ,he'd be better off.
If the FM thought those company shares were overvalued why not sell them himself ?
As I see it on a different angle....and I'm not avinalarf.
Company X is in trouble but possibly viable in the long term.
Then their shares get shorted and they go kaput.
Lots of folks loose their jobs and a viable company goes to the wall.
Isn't this the unacceptable face of capitalism ?
avinalarf said:
Thanks guys ....I'm going to think about your replies.
So if the shorter is successful and the share do fall.
1) what does the lender get out of it, apart from the small premium he gets from the shorter.
2) You still haven't explained how the lender manages the loss.
That is ....if he spent £10mil buying the shares and they tank to 500K he can he be happy about that ?
Surely if the FM sat on the shares and dealt in the market ,as and when ,he'd be better off.
If the FM thought those company shares were overvalued why not sell them himself ?
As I see it on a different angle....and I'm not avinalarf.
Company X is in trouble but possibly viable in the long term.
Then their shares get shorted and they go kaput.
Lots of folks loose their jobs and a viable company goes to the wall.
Isn't this the unacceptable face of capitalism ?
Shares don't move in a straight line so the shorters may work on a short term position but over the longer term they may rise.So if the shorter is successful and the share do fall.
1) what does the lender get out of it, apart from the small premium he gets from the shorter.
2) You still haven't explained how the lender manages the loss.
That is ....if he spent £10mil buying the shares and they tank to 500K he can he be happy about that ?
Surely if the FM sat on the shares and dealt in the market ,as and when ,he'd be better off.
If the FM thought those company shares were overvalued why not sell them himself ?
As I see it on a different angle....and I'm not avinalarf.
Company X is in trouble but possibly viable in the long term.
Then their shares get shorted and they go kaput.
Lots of folks loose their jobs and a viable company goes to the wall.
Isn't this the unacceptable face of capitalism ?
For example -
I buy shares at £1
1 month later they are worth £3
You borrow them to short at £3
They fall to £2 and you close your short - you've made money
The share then rises to £4, etc, etc
I was long term so you shorting in the middle is irrelevant to me.
"Then their shares get shorted and they go kaput." - Shorting shares does not cause a company to fail. It shouldn't affect it at all aside from possible market confidence issues.
You seem to be missing the point.
They dont have to agree, a market is made of different opinions. Only time will tell which is right.
You seem to be focusing on what happens to the fund manager if the short seller is right - well what about if the long holder is right? Short seller sells a stock, then it goes up 10%, they've lost a lot of money. If either side knew exactly what would happen then it would be collusion or insider trading. So both sides just trade an opinion, thats all.
- Short sellers think the market is going down.
- Long holders (usually) think the market is going up.
They dont have to agree, a market is made of different opinions. Only time will tell which is right.
You seem to be focusing on what happens to the fund manager if the short seller is right - well what about if the long holder is right? Short seller sells a stock, then it goes up 10%, they've lost a lot of money. If either side knew exactly what would happen then it would be collusion or insider trading. So both sides just trade an opinion, thats all.
I think the rules have changed since i was in the markets (most profitable day ever was 19th October 1987 
) but one reason why a fund manager may be relaxed about an equity taking a short term drop (which is all the short will achieve) is that they believe in the long term profitability/growth of the equity and will use the chance to increase their holding and therefore reduce their average value as well as get paid to loan the shorter the equities to cover their short.
thinking;
- institution holds 5m shares at £2/per share so £10m
- institution paid £x to loan cover for the short.
- if short drives price down institution buys further 2m shares at £1.5 so now holds 7m at £13m so £1.86 avg.
- equity recovers to £2 per share, inst gains £980,000 plus how much they earnt for the loan of the cover stock.
- if short does nothing the institution does nothing and just benefits from the £x they got paid for the loan stock.
Question is why would the trader do it, surely it would be more profitable for them to do it in options or has "giving for the put" gone by the wayside?
) but one reason why a fund manager may be relaxed about an equity taking a short term drop (which is all the short will achieve) is that they believe in the long term profitability/growth of the equity and will use the chance to increase their holding and therefore reduce their average value as well as get paid to loan the shorter the equities to cover their short.thinking;
- institution holds 5m shares at £2/per share so £10m
- institution paid £x to loan cover for the short.
- if short drives price down institution buys further 2m shares at £1.5 so now holds 7m at £13m so £1.86 avg.
- equity recovers to £2 per share, inst gains £980,000 plus how much they earnt for the loan of the cover stock.
- if short does nothing the institution does nothing and just benefits from the £x they got paid for the loan stock.
Question is why would the trader do it, surely it would be more profitable for them to do it in options or has "giving for the put" gone by the wayside?
avinalarf said:
It helps,
What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
What I don't understand is this....
Why would the " big fund manager " who paid £5 a share lend a chunk of them to someone who wanted to see the share price go down to say £1 a share.
Wouldn't that fund manager be sitting on a huge loss ?
I KNOW I'M MISSING SOMETHING......
Hello Steven,
D.A. knows his subject, and has answered your question.
Let me gave a go.
The institutional investor would usually be a very long-term holder of shares, certainly when it comes to their holdings of big company shares.
Receiving a 5% dividend income from several FTSE 100 companies, is fine for them at present.
They are not interested in the short-term ups and downs of the share price, because they are investors and not short-term traders (gamblers).
Over time, if a company can increase their profits, then normally the share price will eventually increase as well. In addition to the dividend income, that is what the institution will be hoping for. They want a higher share price in say five years time, not next Friday.
Therefore as they are not interested in daily price movements, they can obtain additional money by way of fees from the short-term sellers.
I don't know how often it happens, but remember not every short-sell is a winner. The losses can magnify if they guess wrong, and the share price suddenly rises. A recent occurrence of that was Tesla.
Is my answer helpful?
Jon39.
avinalarf said:
Company X is in trouble but possibly viable in the long term.
Then their shares get shorted and they go kaput.
Lots of folks loose their jobs and a viable company goes to the wall.
Isn't this the unacceptable face of capitalism ?
Then their shares get shorted and they go kaput.
Lots of folks loose their jobs and a viable company goes to the wall.
Isn't this the unacceptable face of capitalism ?
You are getting rather 'carried away' with this Steven.
Short sellers can only push a share price down temporarily.
There would need to be continuously more selling than buying, for a share price decline to continue.
As a businessman you will know, that going kaput happens when a company runs out of money.
A low share price does not cause a company to fail. Short-term share price declines may or may not be, an indicator of actual financial problems within a business.
Anyway tea break over for me now. My entertainment today is felling a 30 to 40 foot high laurel. Must try to finish that task today.
Will try not to drop it on the AM !
Edited by Jon39 on Tuesday 14th August 17:43
Thank you all for helping me understand my query.
It's not that I did not understand the reason that people short a share I just failed to grasp the minutiae and now I have thanks to you lot.
I do take issue however with the fact that if a company has, for instance, a cash flow problem the shorters can drive down the price so much as to make that company fail.
Take Debenhams, a poor example maybe,
If MA shorted the shares then when they became a basket case he would either pick up the company " cheaply " or just let it go into administration and then pick over the carcasse.
Is that how it works " ( rhetorical question ).
From what you guys have said I take it that most shorters are just looking for a quick buck or buckerooloos and not looking to take over or feck the company completely.
However there are hedge funds that specialise in shorting shares ,then gaining board room influence, and completely reorganising that company, selling off assets and property, realising their gains and then walking away with the profit leaving that company a shadow of what it once was.
It's not that I did not understand the reason that people short a share I just failed to grasp the minutiae and now I have thanks to you lot.
I do take issue however with the fact that if a company has, for instance, a cash flow problem the shorters can drive down the price so much as to make that company fail.
Take Debenhams, a poor example maybe,
If MA shorted the shares then when they became a basket case he would either pick up the company " cheaply " or just let it go into administration and then pick over the carcasse.
Is that how it works " ( rhetorical question ).
From what you guys have said I take it that most shorters are just looking for a quick buck or buckerooloos and not looking to take over or feck the company completely.
However there are hedge funds that specialise in shorting shares ,then gaining board room influence, and completely reorganising that company, selling off assets and property, realising their gains and then walking away with the profit leaving that company a shadow of what it once was.
Must admit, I have a hard time understanding how shorting works 'physically' in the underlying market... for example:
I click on a button to open a short.... what happens under the hood?
Note I understand how shorters can gain or get 'burned', my question is around the mechanics of opening/closing a short.
I click on a button to open a short.... what happens under the hood?
- I borrow x number of shares from an institution .... I assume they are instantly sold to market?
- Over a few days the share price drops, I decide now is a good time to close the short... I hit the close button...
- What happens now? ... does my 'closing' action purchase the original x number of shares from the market (at the now discounted price) and return them to the lender (institution)?
Note I understand how shorters can gain or get 'burned', my question is around the mechanics of opening/closing a short.
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