Monday, February 1, 2021

Short Squeeze For Dummies

I've always been a dummy investor, so the whole Gamestop deal was a mystery -- especially since I no longer follow the MSM, it had to show up on Power Line before I cared enough to look. 

The Spectator has a somewhat interesting column on more of the psychology and real world human effects. 

There is a lot of sadness about our tragic money obsessed culture in the link -- the profanity is just the beginning: 

And boy has it worked. The user who first pitched GameStop on Reddit is called DeepFuckingValue. His original investment of $50,000 is now worth $50 million. This weekend he celebrated his gains in a video by dipping chicken tenderloins in a glass of Champagne. He still hasn’t sold.

For the congenitally stupid like me, the Kiplinger link covers it well -- I DID know "selling short" is betting the stock goes down, I just had a VERY foggy idea of what the mechanism was. 

Short selling – or shorting – is placing a bet that a stock declines in value. To do this, you borrow shares from another investor and then sell them. (Your broker does this for you behind the scenes.)

But remember: Those shares aren't yours to sell. You borrowed them. This means you are obligated to buy the shares back so you can to return them to the original owner.

There is an old saying attributed to Daniel Drew, a legendary speculator of the late 1800s:

"He who sells what isn't his'n, must buy it back or go to pris'n."

They don't send bankrupt short sellers to prison anymore, but the obligation to buy the shares back is very real. And this is where short squeezes come into play.

In the physical world, it would be like you borrowed 100 rounds of ammo from your friend when you went to the range, because you thought you were a little "short". Assume ammo was going for .10 a round  (so $10 for the 100). A guy at the range was buying ammo at .10 a round (he didn't bring enough) and you decided you were done shooting, and sold him what you borrowed ... so now you have $10, and no ammo. 

Unfortunately, you forgot to get more ammo, and now you are out. So when your friend asks for the ammo back, you find that ammo has gone up to $10 a round (where it is today BTW if you can get it) ... so you have to pay $100 for it, and therefore lost $90. 

The market (broker) doesn't trust you like your friend, so you have to "cover" as the price of the stock rises ... and keep covering as the price goes up -- and it can go up A LOT, theoretically infinitely. If you can't cover, you MUST actually buy the stock and give it back, thus making the stock rise in "value".  (the scare quotes are because the underlying real world value of the stock (the earnings of the company and sale price of its assets) are often way less than the stock price. In markets, "value" is whatever people are either willing -- or forced to pay if they can't cover the margin call. 

So short selling is very risky ... your potential gain is limited, your potential loss is unlimited. 

Naturally, on the chance you buy the actual stock at $10 (ammo at .10 a round) and it gets into a "squeeze" (like say Biden gets elected and he bans ammo sales), and stock (ammo) goes up to $1,000, AND YOU SELL IT, you made $990. (often, the other problem is that you are greedy, don't sell in time, so just lose your $10) 

... and now you know why I have a stockpile of ammo.  

Things like the Gamestop squeeze add to to the uncertainty of markets -- people have to sell assets they otherwise would like to keep in order to cover the margin -- other stocks, or maybe gold, thus causing their values to drop -- at least temporarily. 

So I think I understand it now -- always dangerous! 

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