Friday, April 04, 2008

81% in Poll Say Nation Is Headed on Wrong Track

...the 19% that disagreed had been shorting Bear Stearns stock.

shorting a stock

shorting a stock means to sell shares which an investor doesn’t own, but has temporarily borrowed.

the investor’s hope is to borrow the shares of stock, sell them at a high price, wait for the price to fall, buy them back at the lower price, return the borrowed shares to their original owner, and pocket the profit. the profit, in this case, is the difference in price between when the investor “sold high” and then “bought low”.

let’s take a look at an example. the very yellow investor, flat eric, believes that bear stearns’ common stock, which was selling at $70 per share on a recent friday, is overvalued. being flat, yellow, and eric, he thinks he can make a quick buck or two, and borrows one thousand shares of bear stearns from another investor who owns the stock. flat eric then immediately sells the borrowed shares for $70 each. the borrowing of the shares is usually facilitated by the brokerage firm that the investor uses to execute the short sale.

after selling the stock, flat eric sits and waits. its value falls to $40 per share. at this point flat eric very cleverly repurchases the thousand shares, returns them to their original owner, and retains a profit of $30 per share, less the expenses of margin interest and transaction fees.

shorting a stock must always be done in a margin account in order to protect the party who lends the shares. a margin account is a brokerage account in which the broker lends the account holder cash with which to buy securities. because of investing with the use of leveraged money, possible gains and losses are substantially increased.

in our example above, because flat eric is shorting one thousand shares of a $70 stock, he would have to deposit $35,000 into a margin account (fifty percent of the value of the shorted stock). when the shares are actually sold, the proceeds of $70,000 would bring the margin account’s balance up to $105,000. this serves as collateral for the short sale by insuring that the party who shorts the stock, in this instance flat eric, has the funds available and ready to repurchase the shares so that they can be returned to their original owner.

outside of any expense fees, flat eric has just made $30,000.

to give you some idea of how much money was made by bear stearns going down, their stock was being traded at $70 on the friday, and by the following monday the stock was being traded at $6 a share…

that’s right, shorting just 1,000 shares of bear stearns stock would have made a profit of $64,000 with an investment of $35,000.

now, what do you think the big players on wall st. made?

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