Just a short description of a shorting stock.

1. INTRODUCTION TO A SHORT
SALE AND A SHORTING STOCK
Tutorial
Alikberov Andrey

2. 1
Table of Contents
The Background..................................................................................................... 2
Shares vs Bonds .................................................................................................. 2
The Market ......................................................................................................... 2
Indicators............................................................................................................ 3
Influentors in financial markets: ......................................................................... 4
Introduction to a Short Sale................................................................................... 5
Short Sale or Shorting Stock – a type of bet........................................................ 5
Risks of short selling ........................................................................................... 5
Is shorting bad? .................................................................................................. 6

3. 2
The Background
Shares vs Bonds
It is important to know the difference between shares and bonds.
1. Shares (or Stocks) – by purchasing stocks you become a part of a company,
or shareholder. You are paid interest from shareholder’s equity.
2. Bonds – by purchasing bonds, you are lending money to the company.
The Market
1. Price of a stock / Share price = equity/shares outstanding
 Ex. Company X has Assets of $30 million, Liabilities of $22 million and
Equity of $8 million. Total number of shares is 2.78 million
Price of a stock = $8 million /$2.78 million = $2.87 per share – that is
what we should be willing to pay for one stock or we think of fair price
per share of this company is, if we think that company’s assets are really
worth $ 30 million.
2. Market capitalization = shares outstanding * the share price
 The more market capitalization you have, the more liquid is the stock
and contrarily.
a. Small cap: it refers to a company with a market capitalization
between 300 million and 2 billion. Due to restrictions, asset
managers are not authorized always to take big positions in small
caps in their portfolio, meaning that small caps are mostly hold by
private investors. Historically, they tend to perform better than mid
and big caps but are riskier because of lower volumes.
b. Mid cap: it typically refers to companies with a market
capitalization between 2 and 10 billion.
c. Big cap (also called large cap): companies with a market
capitalization of 10 billion or more.
3. Quality of stocks
 You have different quality of stocks, some of them are called:
a. Blue chip: it refers to a worldwide recognized, well-established and
financially good company. They are known to handle crises and

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downturns without problems, and, operate profitably in all
environments. A blue chip is usually less volatile and follows more
or less the path of the S&P 500.
b. Black chip: it refers to the best blue chips which distribute high
dividends. A few famous investors invested only in these stocks to
make money over a long period of time.
Indicators
 Last trade – the last price of a stock of a specific company in the exchange
market.
Suppose the same company, whose price of a stock that we have previously
calculated is $ 2.87 per share. However, last trade, that is, the latest price of the
stock in the end of the day, was $ 2.32. Why traders are buying and selling firm’s
stock for such a discount, as it is lower that the stock price we have just calculated?
o Buyers: those who buy the stock for such a price think that the
company’s assets are worth $ 30 million and the stock price will go up
o Sellers: those who sell the stock for such a price think that the company’s
assets aren’t worth $ 30 million and the stock price will go down
 Bid – price for which buyers are willing or ready to buy a security (e.g. 2.46
euros per share)
 Ask – price for which sellers are willing or ask to sell a share (e.g. 2.58 euros
per share). It is always higher than the bid price.
 Bid-ask spread – amount by which the ask price exceeds the bid. This is
essentially the difference in price between the highest price that a buyer is
willing to pay for an asset and the lowest price for which a seller is willing to
sell it.
 Average volume – number of shares sold per day (of a specific company)
 Market cap - amount of money for which shareholder’s equity of the
company is worth in the market’s mind (if a certain firm’s shareholder’s
equity is 8 million, it does not mean that market cup of the same company is
8 million). In is calculated by the formula outlined below:
o Market cap = Last trade * shares outstanding

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Influentors in financial markets:
 Big Companies (especially when release financial statements)
 Banks
 Financial Press
o Financial Press is making money by selling ads to financial service
companies.
o Customers of the financial press are money managers, brokers,
financial planners, mutual funds
 Broker
 Dealers
 Sell side analysts & Buy side analysts
o Sell side - The part of the financial industry involved with the creation,
promotion, analysis and sale of securities. Sell-side individuals and
firms work to create and service stock products that will be made
available to the buy side of the financial industry. The sell side of Wall
Street includes investment bankers who serve as intermediaries
between issuers of securities and the investing public, analysts who
perform stock research and make ratings, and the market makers who
provide liquidity in the market (Investopedia).
o Buy side - The side of Wall Street comprising the investing institutions
such as mutual funds, pension funds and insurance firms that tend to
buy large portions of securities for money-management purposes.
The buy side is the opposite of the sell-side entities, which provide
recommendations for upgrades, downgrades, target prices and
opinions to the public market. Together, the buy side and sell
side make up both sides of Wall Street.
 Government
 Short sellers
 Investors

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Introduction to a Short Sale
Short Sale or Shorting Stock – a type of bet
 If you go long – you are buying the security
 If you go short – you are borrowing the security and selling it
As you know, you could borrow a security from a broker. When you are borrowing
a share, the broker gives you stock of a random shareholder and you can sell that
stock. What is the purpose of a short sale?
Imagine the IBM share price is $ 100 per share, but you think the price will
go down. You can simply lend a stock from a broker, sell the stock for $100 and
wait till the price go down. Suppose the share price as you thought went down
from $100 to $50 per share. After that you are buying back IBM share for $50,
give back to your broker and have $50 left (or you are buying 2 shares)
However, by lending a stock you have to
 pay stock rent (interest) to broker
 pay interest (dividends) to a shareholder via broker (who actually own the
stock I borrowed) in case the firm decided to pay dividends
The aim: if your strategy is usually “buy low, sale high”, in a short sale you do vice
versa – “sale high, buy low”.
Risks of short selling
Imagine you borrowed IBM stock from a broker and sold it, thinking that the share
price of IBM would go down. However, on a date when the company released their
financial position and it revealed that a firm did much better than anyone could
have ever expected, so that the stock went up.
You sold a stock
$ 160
$ 100
IBM report
Time

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You have to give back the borrowed share to a broker by paying now a share for a
new share price of $160 and have a loss of $60.
Is shorting bad?
Short seller making – borrowing the stock and selling it, gaining some margin. By
doing this, short seller making reduce the volatility of the stock. Why?
Imagine the market that does not have short sellers, shown by the graph with a
blue line.
Now imagine there are short sellers came to the market. They start selling the
stocks at peaks and buying at the bottoms (It is obviously unlikely that all of them
are so well picked up at bottoms, but assume that they are all perfect sellers that
know their business).
So, short sellers sell stocks at peaks, but they have to cover their position by buying
new shares. Therefore, at a low points you have more aggregate buyers covering
Time
SELL
COVER
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P
Time
COVER
SELL
COVER
SELL

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their short positions, meanwhile at peaks you have more aggregate sellers. As you
can see, with the introduction of short buyer and sellers, (green line), the prices
are not going as low and as high, as it would be without them. Shorting stocks at
peaks and covering stocks at bottoms help to reduce the volatility of the stock, and
that is good for everybody, including the company’s management and its actual
shareholders.
As you may notice, reduction of volatility is not only related to short traders but to
anyone who makes money on a stock market and adds some value into the power
of aggregate buyers and sellers, including regular traders, who, on the contrary,
buy stocks at low points and sells at high points. Similarly, those who considered as
“bad investors”, selling their stocks at low points and buying at high ones, increase
the volatility of the stock.
Now you were introduced to the basic concept of a shorting stock. However, it is
much more interesting to get an inside of a concept a bit deeper.
Challenging, isn’t it?
SHORT
SHORT
SHORT
COVER
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Time
COVER
COVER