SHORT-SELLING: A PRIMER

  • Updated: September 19, 2008 - 11:49 PM

SHORT-SELLING: A PRIMER

Selling a stock short is, in essence, a bet that the price will fall. Here's how it works:

• The short-seller borrows 1,000 shares of a stock from a broker, then sells them on the market for $25 a share -- $25,000.

• The stock's price falls to $15 a share. The short-seller buys 1,000 shares at that price -- $15,000 -- to pay back, or cover, what was borrowed.

• The short-seller pockets a profit of $10,000.

What's the risk? If the price of a stock rises, short-sellers lose money -- and there's no limit to how much a stock can rise.

Is it illegal? No. In a booming market, short-sellers can be a needed restraint on overvalued stocks. They can also cushion a stock's fall as they buy to cover their positions.

Then what's the problem? CEOs have long complained that short-sellers spread negative rumors to drive down share prices. And in a "bear raid," an influx of short-sellers into a stock can cause other investors to flee, pushing the stock price down in a vicious cycle.

What's "naked" short-selling? That's selling stock short without borrowing it first -- also not illegal as long as the stock can be delivered quickly.

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