Board 8 > One thing I still don't understand about this whole gamestop saga

(+) Yeah! (+)

Every article I see talks about short selling like it's a simple and easy to understand concept. I finally broke down and looked up outside articles to explain what short selling is, and the explanation was as follows:

1. Borrow shares of a stock.
2. Sell those borrowed shares.
3. Wait for the price to fall.
4. Buy replacement shares for the ones you borrowed.

So instead of paying someone back the $20 you borrowed, you're paying back your broker the stocks that you borrowed from them. It's a reverse buy-low-sell-high. That is, it's sell-high-buy-low. But how do you borrow stock? Like, why would anyone lend a stock? "Hey, can you lend me your stuff so I can sell it? I promise I'll give them right back, good as new."

Admittedly, I know very little about how stocks really work. I could probably ask a billion other questions about the market.

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azuarc posted...

Like, why would anyone lend a stock? "Hey, can you lend me your stuff so I can sell it? I promise I'll give them right back, good as new."

Because they get paid to do so. Similar concept to charging interest on traditional loans.

The person borrowing the stock typically needs to offer some sort of collateral, it's not like they are just giving their word.

And if i was planning to hold the stock anyway, then i don't mind someone borrowing it from me if i can charge them a fee to do so.
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The biggest issue with you understanding is thinking it's as simple as X money goes in, X money comes out. There are a million ways the money is taxed, interested, etc between shorting a stock and getting your money back out

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Like, why would anyone lend money? "Hey, can you lend me your money so I can spend it? I promise I'll give it right back, good as new."

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Shut up guiga

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DeepsPraw posted...

Like, why would anyone lend money? "Hey, can you lend me your money so I can spend it? I promise I'll give it right back, good as new."

But when you lend money, you get more money back in return. Are you implying that when lending stocks, you get back more stock in return?

And yeah, aecioo, I don't know crap about the process. I'm always amazed at how the stock market seems to magically create money out of nothing, but surely that money came from somewhere, right? It's not that the price of a stock goes up just because we say it does and then suddenly everyone with shares has a more valuable portfolio. At least, I hope not. But it certainly doesn't feel like a zero-sum process.

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azuarc posted...

It's not that the price of a stock goes up just because we say it does and then suddenly everyone with shares has a more valuable portfolio. At least, I hope not. But it certainly doesn't feel like a zero-sum process.

This is exactly what it is.

The more people buy, a stock goes up, the more people sell, a stock goes down. With the billionaire class owning more wealth than they ever have before, so much of the stock market is just billionaires throwing their money at stuff. Guess it's just never been exposed to the masses until the biggest bull market ever happened last year while Covid ravaged the economy, and GME short squeezed to infinity and beyond.

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The way I THINK it works is this:

Person A borrows stocks from Person B with the intention of selling the stocks, and then buying them back as the stock price goes lower, thus making a profit in terms of the difference between the sell price and the buy price.

Person B allows the borrowing of the stock, but requires payment in order to allow the borrowing (interest, collateral, whatever you want to call it.)

Person A's goal is to sell the stock and allow the price to fall low enough that they can buy it back and recoup the losses incurred by the interest charged by Person B.

Person B's goal is to charge enough interest that they make up the difference in price when the borrowed shares of stock decrease in value. They might even be lucky enough to have a situation like the current one, where the stock prices are inflated AND they've already received interest payments.

Can someone else verify this? Is that accurate? Because that's the only way the system makes sense to me.

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azuarc posted...

But when you lend money, you get more money back in return. Are you implying that when lending stocks, you get back more stock in return?

It's not a one-to-one comparison, but I couldn't resist making the joke. Basically the borrower has to pay a margin, which is like the interest on the loan.

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I don't understand this part either.

BUT my guess is, the owners of the shares, when they lend out the shares, they charge a fee upfront, that isn't based on the share value, just some constant fee. So, the owners of the shares do make money off of this--in fact, it's probably risk-free easy money for them, since they get their money immediately, and the borrowers are obligated to give the shares back in the end.

Whereas, the people borrowing the shares, are only going to make money if the Short goes according to plan, so there's risk there. BUT they make more money than the original share owners, as long as it all goes right.

Don't know if any of that is true, just my guess.

EDIT: Oh Inviso said this same thing 2 posts above.

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Yes, but usually person B actually expects the value of the stock to go up. In normal stocks the interest is a nice bonus, but not really enough to justify holding a stock if you think it will fall. In GME though, the interest is sky high so it might be worthwhile for a long term investor just to hold for the interest.

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Epyo posted...

BUT my guess is, the owners of the shares, when they lend out the shares, they charge a fee upfront, that isn't based on the share value, just some constant fee

False

Very false. It involves a lot of math.

https://en.m.wikipedia.org/wiki/Black%E2%80%93Scholes_model


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Person B's long term intentions are very relevant as well.

If I firmly believe that a stock is undervalued and will recover (maybe because there is a pandemic causing issues that won't last forever) then I might buy a stock with the idea that it will be worth something in a couple years. And it might vary a bit between now and then but I'm in it for the long hall because I'm confident in the eventual recovery effect.

If someone wants to pay me to borrow that stock for a few months then that's basically free money if that same stock was just going to be collecting dust during that same time.

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Epyo posted...

I don't understand this part either.

BUT my guess is, the owners of the shares, when they lend out the shares, they charge a fee upfront, that isn't based on the share value, just some constant fee. So, the owners of the shares do make money off of this--in fact, it's probably risk-free easy money for them, since they get their money immediately, and the borrowers are obligated to give the shares back in the end.

Whereas, the people borrowing the shares, are only going to make money if the Short goes according to plan, so there's risk there. BUT they make more money than the original share owners, as long as it all goes right.

Nope. The difference where you close the position makes you the same percentage of return on investment no matter where it is. So if you short a stock at $100 and it goes to $50, you make 100% return on investment. And if you buy a $50 stock and it goes to $100, you also make a 100% return.

It's a very risky practice with no special benefits. It's usually done on pump and dumps, where prices are seen as way over inflated and eventually coming back down, or failing companies. But since no one knows what the market will do, there is always infinite potential losses when shorting a stock, whereas investing in a stock, you only risk to lose what you invested in the first place.

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StartTheMachine posted...

It's a very risky practice with no special benefits.

I take issue with this, too. Derivative options are inherently risky, as we've seen with the past week, but arguing that there's no special benefits seems misplaced to me.

Calls and puts are options that can be leveraged for different risk portfolios.

(All that being said I do think that the stock market is a dumb thing and creating value out off nothing is silly money magic)

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Peace___Frog posted...

I take issue with this, too. Derivative options are inherently risky, as we've seen with the past week, but arguing that there's no special benefits seems misplaced to me.

Calls and puts are options that can be leveraged for different risk portfolios.

(All that being said I do think that the stock market is a dumb thing and creating value out off nothing is silly money magic)

Shorting stocks is not the same thing at all as options trading. Puts are a similar concept, I suppose, as you're making money when a stock goes down in value, but they are very different practices than literally borrowing shares and selling them immediately to open a position.

But yeah, the percentage gain on options trading is very lucrative, though options trading is also risky. Naked shorting is both riskier than options trading and it doesn't come with the inherent leverage benefits of options trading.

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The part I don't get is how there were over 100% of stocks short sold. I'm guessing someone short sold stocks to someone else who then short sold the same stocks to yet another person?

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Imagine there was only 1 stock. Joe borrows it from Sam and sells it to Sally. Now Paul can borrow it from Sally and sell it to Craig. Only one stock, but it's been short sold twice.

That demonstrates the concept.

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