shorting

a traditional short sell, or short for…short, you borrow an asset that you believe will decline in value, sell it, then buy it back before it’s due to be returned. for instance, suppose acme stock is at 2300 and you believe it will fall below 2000 in one month. you borrow x shares and sell them. then you buy them back in a month and pay back the shares, pocketing the difference if you’re right, or potentially losing money if you’re wrong. note that you also pay a fee anywhere from 0.3% to 3% per year for borrowing the stock.

#math

this can be numerically simplified. we just say that the owner of the shares will pay you c — fin one month, where c is the current price and f is the future price (plus the aforementioned fee of course). under this simplification, the other party need not even own any shares.

shorting a person

but what if you want to short an individual rather than the market? suppose bob owns acme stock which is at 2000, but he believes it to be worth 2300. it turns out the same mechanism works. you pay bob a shorting fee and he pays you c — f at some agreed upon future price. if you’re right, then bob ends up paying you 2300 — 2000 = 300. if bob is right, he’ll end paying you nothing.

keeping the asset

but what if you want to short the asset and keep it? in other words, bob is going to give you the asset right now, and you’re going to pay him some amount in the future. what should that amount be? it turns out it’s just 2f — e, where e = bob's current expectation. if you’re right, you’ve effectively purchased the asset for 4000 — 2300 = 1700, pocketing the 300. whereas if bob’s right, you’ve purchased the asset for 4000 — 2000 = 2000, which means bob’s lost nothing and you’ve gained nothing (save for the shorting fees just like in a normal short.)

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Clay Shentrup

Clay Shentrup

advocate of score voting and approval voting. software engineer. father. husband. american.