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Short investing

To go “Short” in the context of an investment refers to a negative holding of something (selling something you do not own). It is the opposite of long investing.

“Net short” is where an investor has more short positions than long positions in a given asset, industry or market  in his / her portfolio.

EXAMPLE: When investment manager A does not own a stock and wants to short sell it, he / she must first borrow it from investment managers that do. The lending manager B will charge a margin for this. The reason that the manager A must borrow stock is that when it is sold on the main market, stock must be delivered before the cash is paid.

When, as manager A expects, the share price falls, they can be brought back at a far cheaper price than the sell and returned to lending manager B. The gain from the short is difference between the money that manager A got from the sale of the borrowed stock and the cost to buy back at a lower price and the margin charged by manager B.

However, if the stock price rises, the cost of buying it back is greater. Therefore, the loss is the price to money that manager A got from the sale of the borrowed stock, minus the cost to buy back at a higher price and the margin charged by manager B.

Stock lending is a good way for investment managers to derive other earning streams from a portfolio. They are also a risk, as the need may arise for manager B to sell it from their portfolio when it is still with manager A. Therefore, the agreement to lend may include a covenant to return the stock on demand. This passes the risk to borrowing manager A .

 

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