So if you are new to investing and you see everybody going on about shorts vs. longs and wonder what’s the big deal, here’s a few thoughts for you.
Firstly, what is a short? A short seller is someone who thinks the price of the stock should go down, so they ‘borrow’ a stock from a brokerage house and sell it to a buyer. The short seller then pays interest to the brokerage house for using the ‘borrowed’ stock.
Most of the time, the actual owner of the stock has no idea their stock has been borrowed or sold and should they want it to sell themselves, the brokerage house is responsible for supplying a replacement stock instantly.
The weird thing about short selling a stock is that you could say it ‘artificially’ lowers the share price because the same share gets sold twice and bought once. (until the short buys back the stock to cover their position)
To expand on this thought…..the original purchase of the stock involves the new owner (Buyer1)buying the stock from a seller, there is a buy and a sale. However, the short seller then ‘borrows’ the stock from Buyer1 without their knowledge and sells it to another buyer (Buyer2) and now theoretically 2 people own the same stock, Buyer1 and Buyer2. The short seller receives money from Buyer2 and is responsible for returning the stock to the brokerage from which they borrowed it at some time in the future at the prevailing market price.
This short selling activity essentially creates stock from ‘thin-air’, two people own the same stock and one person (the short seller) is negative that stock.
How does this devalue the price per share? Quite simply it dilutes the total shares outstanding, in the case of AMD that currently has total shares outstanding of 947 million and short shares of 140million, shareholders have literally bought 1087million shares, it’s just that 140million of those have been written on ‘IOU’s.
At a current PPS of $25 , if AMD was valued at the number of shares purchased (total shares+shares sold short = 1087mill) then its market cap would be 27.175bn but it’s actual market cap is 23.675bn.
If the higher market cap of 27.175bn was applied back to just the total shares outstanding then you get a PPS of $28.69 if there weren’t any short shares!!
Of course that’s a very simplified explanation of how it works but you get the idea.