On Wall Street the talk of the month was Game Stop. Many readers might already be familiar with the bizarre case that shook the American stock market through a collective action coordinated on the popular social media Reddit.
If you have not heard of it yet, I recommend it as a very interesting and controversial case that is still awaiting to show who the winners are. And since it is still pending, I have decided not to talk of Game Stop specifically, but rather write a more generic colu million around the concept of “shorting” the market.
First of all we need to clarify that the stock market is made of shares that represent fractional ownership of companies and corporations.
Shares can be bought and sold by anyone on the market, provided that someone else is willing to buy or sell accordingly.
As such, the market “breath” is made of sales and purchase orders.
Virtually every second shares move from one hand to another at different price, generating a profit or a loss for the seller. The buyer stocks up shares wishing to sell them later at a higher price.
However, when the trend is downward and buyers believe that prices might go down, they can “short” the stock.
Imagine that the hypothetical share A is now priced at $100 and you are confident that go down to $90, but you do not have any share A.
Now let us say that someone else has one share A and — unlike you — believe that the price might go to $110.
To enact a short you could rent that one share for $2 today and return it next month. It is important to highlight that you will return the share, not the amount of money that the share is worth.
So, now that you have rented a share without buying it, you are down $2 only. You can then proceed to sell it on the market at the current price of $100. At this step you have $98 with you.
Next, you wait until the price goes down.
If you were right and the price indeed goes to $90, you can then use the $98 to buy one share A from the market.
You have a balance of $8 in your pocket and you can now return the share to the owner that rented it to you.
The owner would now have one share A and $2.
Some reader might be thinking: “that does not seem like a good deal for the owner of the share.”
In fact, now the share is worth less and the owner has only earned $2. True.
On a quick analysis it was not the best deal for the owner, but the owner was confident that price would have climbed to $110.
If the price indeed went up, then you would have had bought back the share at a higher price and your loss would have been $12, while the owner would have still earned $2 on top of $110 worth of a share A.
The market is — to a certain degree — predictable, and as always, some win and some lose.
[The writer is a member of the International Press Association]
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