No Shortage of Risk Involved in Strategy
You want to be a short seller? Many of the pros who do it for a living would advise against it. There is no more difficult, time-consuming or risky investing strategy, they say.
Consider: If you simply buy a stock to own it, the most you can lose is 100% should the stock go to zero. But when you short a stock, your losses are potentially unlimited if instead of falling, as you expected, the stock rises.
If you sell a stock short at $20, for example, and it soars to $60 before you close out your position, your loss is $40 a share--double what you sold it for.
Nor is there an easy answer to the question of how much of a paper loss to endure before finally throwing in the towel, says short seller Bill Fleckenstein of Fleckenstein Capital. “I can’t tell you how many times I’ve been run over [by a shorted stock’s surge] just before I was right” about its decline, he says.
Still, if you want to make bets that individual stocks, or the market overall, will decline, there are many options:
* Major discount brokerages will allow you to short stocks, once you set up a margin account. When you short an individual stock, you direct your broker to borrow the shares (most likely from a brokerage’s inventory) and sell them at the current market price. The proceeds are left with the broker as collateral for the stock loan, until you close out the position by repurchasing the shares in the open market--at whatever the prevailing price is.
In the meantime, you will also have to deposit with the brokerage an amount equal to half the stock sale proceeds, because you are, in effect, investing with borrowed money.
* A handful of open-ended mutual funds regularly use short selling as part of their investment game plan. They include Robertson Stephens Contrarian ([800] 766-3863), Lindner Bulwark ([314] 727-5305), Rydex Ursa ([800] 820-0888) and Prudent Bear ([888] 778-2327).
As always, read a fund’s prospectus closely before investing; some of these funds also invest in things you may not want (gold, for example).
* For relatively low cost, you can effectively short individual stocks using put options, where available. And you can short the entire market using futures contracts, such as on the blue-chip Standard & Poor’s 500-stock index, if you’re so inclined.
Another easy way to short the S&P; is by shorting “spiders”--Standard & Poor’s depositary receipts, or SPDRs, which trade on the American Stock Exchange. They mimic the performance of the S&P; 500 because they are beneficial interests in a trust that holds a portfolio of the stocks in the index.
