|How shorting works.|
|Written by L. M. Lloyd|
|Tuesday, 24 May 2011 00:31|
In a previous article, I explained how one aspect of the stock market works, in the plainest language I could. After talking to a few people, I realized that there was another, more basic function of the market, that a lot of people are confused about, and that is shorting stocks, or selling short. A lot of people don't really understand how you make money off of a stock losing money. In fact, it is very counter-intuitive (at least to honest people), so I want to try to illustrate it as simply as possible, with as little Wall Street jargon as possible. It really isn't that complicated, but the way people talk about it makes it seem a lot more cryptic than it really is. So, let's look at how you 'short' a sale.
Say you are a camera buff, and have lots of friends who are camera buffs and professional photographers. One of your friends has so much equipment, he could never use even half of it. He has one lens in particular, that you are really interested in. The reason you are interested, is because it sells on Ebay for as much as $2,000, but you have heard a rumor that it is about to be replaced by a newer, better version. You know that when the new lens is released, the value of the current lens will drop through the floor, because everyone will be selling them to get the new one. So, you get an idea. You get your friend to rent you his lens for $10 a month, with the promise that after a set amount of time, for this example let's say three months, you will return it (or one just like it if something happens to it) to his collection. As soon as he rents it to you, it immediately goes up on your Ebay page for sale, and you end up getting $2,000 for it. Two months later, the new lens you heard rumors about comes out, just like you hoped it would. As you predicted, the old lens plummets in value, as everyone unloads them, and you are able to buy one for $500. You then return the $500 replacement to your friend, and walk away having made $1,500 on your $30 rental fee. You have just completed your first successful short.
Now, I can already hear a plethora of responses to this scenario, and will say that I am firmly with those of you who say "what a scam!" However, playing devil's advocate, I know that the sort of schmuck who idolizes Wall Street, would unequivocally say that you didn't just screw your friend, you just took advantage of his lack of sophistication, and did something he would have done himself, had he been smart enough. I'm sure that this same person would be quick to point out that you put more on the line than just $30, you also exposed yourself to risk. To be fair, this is true, because if, for example, instead of replacing the lens, they announced that it was discontinued, and they would not make it anymore, then the price probably would have gone up, and you would have lost money on the deal, because the replacement would have been more expensive than the sale price you received for the original. Factually I can't argue with the logic of that. My objection is not factual, however it is philosophical.
Here is the objectionable point; you didn't earn the money, you took advantage to acquire the money. You took advantage of being in the position of knowing someone who had the lens in question. You took advantage of their willingness to rent it to you at a rate that made the trade profitable to you. You took advantage of information you had, which neither the person renting it to you, nor the person buying it from you, was aware of. And lastly, you took advantage of the letter of the rental contract which allowed you to replace it with the same model of lens, instead of the exact same lens. Now, the 21st century hyper-capitalist would surely say "don't be so naive, that is what business is all about, leveraging your advantage for profit." Problem is, the boring old 20th century ethicist would point out, down that road lays the logical conclusion that if you forget to lock your door, then there is nothing wrong with someone walking in and taking everything you own, because they are just taking advantage of the fact that you thought you locked it, but didn't. Here we see again that the logic of the Wall Street businessman, is identical to the logic of the grifter running a confidence scam. It isn't their fault for draining your bank account, it is your fault for trusting them with your account information to begin with. You should have known they had an angle, and known that if you aren't the grifter, then you are the mark.
I could, and have, and probably will again at some point, go on about why ethics aren't about being nice, or polite, or a good person, but are rather the absolute and unavoidable glue that holds our civilized society together, but I will leave that for another time. For this description, I think it suffices to simply point out that the logic of the short, is the same logic of Three-card Monte, or the Nigerian Prince email. To some people, it is inherently obvious that just because you can make a profit doing something, doesn't mean you should make a profit doing it. To others, that is a distinction that is beyond them. Today it isn't my goal to argue the point, but just to make it clear to those who mistakenly think of stock traders and investment bankers as somehow better people than that sketchy guy on the corner with the card table, that just because they have nice suits, private jets, and fancy offices, doesn't mean they are any more trustworthy or honest, than the guy trying telling your grandmother she won the Canadian Lottery.
|Last Updated ( Tuesday, 24 May 2011 02:06 )|