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Author: krystoff One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 44593  
Subject: Newby Qs on short-selling as a price-freeze etc. Date: 3/22/2012 2:17 AM
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Hello friends of the CAPS "Shorting Stocks" forum. I only started short-selling last week. (Wish me luck!) And I am not here today to discuss my shorting strategy. Instead, I have some basic newby questions about short-selling itself. Thank you anyone for any help.

1. ISN'T IT BETTER TO SHORT AN ETF THAN TO BUY AN INVERSE ETF--BECAUSE SHORTING HAS NO SIGNIFICANT FEES?
2. IS IT FEASIBLE TO USE TRADITIONAL SHORT-SELLING TO FREEZE THE VALUE OF PHYSICAL GOLD ASSETS? (& SILVER & PLATINUM.)
3. ARE OPTIONS BETTER THAN SHORT-SELLING FOR THE PRICE-FREEZING OF ASSETS?



1. ISN'T IT BETTER TO SHORT AN ETF THAN TO BUY AN INVERSE ETF--BECAUSE SHORTING HAS NO SIGNIFICANT FEES?

As everyone knows, an inverse ETF is inefficient. Over a year, it will often end up -10% lower than the true inverse. It is only "maybe" useful for short-term trading. And even in that case, isn't it better to use another method which does not carry the -10% annually? I want that 10% annually to go into my pocket, not into overhead. It seems to me, the only downside to short-selling vs. inverse ETF is that you can lose more than you expect. However this seems virtually impossible when shorting an entire index, which is never going anywhere very quickly.

I.e., it seems to me that an 'inverse ETF' is like playing poker at a casino with a huge 'table fee'. Win or lose, you must pay this added cost. Shorting an ETF is the same game but with negligible table fees.

Last year, I read in the CAPS MI forum that short-selling backtests are very problematic, implying that the fees of shorting vary and the more attractive a short position is, the higher the fees. (?) At that time, I had never done short-selling, so I did not question these statements. However, now that I am doing short-selling, I do not find any significant 'fees' except margin interest and the usual trade costs (1/2c per share at InteractiveBrokers, usually amounting to the $1 minimum if you only trade with stocks above $2).

Questions:

a. Am I correct to conclude that the person complaining about the 'fees' was talking about options? Traditional short-selling has no such 'fees'? This is my experience and also what Fool.com's 'Short Selling FAQ' seems to imply, which generally disparages the use of options. http://www.fool.com/FoolFAQ/FoolFAQ0033.htm

b. What is the APR (annualized percentage rate) of a typical 'margin interest'? IB has an interactive 'interest charged to you' page at http://www.interactivebrokers.com/en/p.php?f=interest&ib...
...I put in $10,000 and it reported back 1.65%... but is this daily, monthly, annually (APR) or per-position?

c. Other than that, during my 1-week of short selling, I have come across ADR fees, temporary moratoriums, and a few other anomolies. But so far, I find no significant shorting fees.


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2. IS IT FEASIBLE TO USE TRADITIONAL SHORT-SELLING TO FREEZE THE VALUE OF PHYSICAL GOLD ASSETS? (& SILVER & PLATINUM.)

This week, I stumbled on an article that suggests short-selling your own positions as a method to avoid short-term capital gains taxes. http://seekingalpha.com/article/400371-dodging-taxes

It occurred to me that the same method can be used to freeze the effective value of gold, silver and platinum assets. Why? Please note that gold has two separate attractions:
-- GOLD IS AN INVESTMENT. You believe the price will go up.
-- GOLD IS SAFE MONEY--a bulletproof alternative to FDIC accounts.

PROS. If this works--the result is technically 'safer' than FDIC or US Treasuries. USD$1k in --> USD$1k out. Totally guaranteed regardless of bank failures.
CONS. Even if this works--you can expect $0 appreciation. Zero protection against inflation or the collapse of the US dollar. (Assuming you short in US dollars.)

Walking myself through what might happen...

SITUATION 2a: "Gold Up".

* You start with $10k of gold and a $10k short on GDX.
* Later, imagine for example your gold is $15k and your short is $5k. You sell $5k of gold and repay $5k owed on the short. US citizens pay 'commodities' tax on the 5k--but you have a 5k deduction on your regular/short-term/earned income. If the deduction outstrips one year of earned income, you can take as many years as necessary to sell down the gold. So, seems the only problem here for US citizens is--whether or not your 'regular' tax rate might be lower than 28%.
* If your tax bracket is only 15%, then according to my calculation, you lose about -3% of total value in the above example. Or suppose gold triples against the dollar, then maybe you lose about -10%. However, this might be a fair price to pay for the total insurance against losing -40%.
* If your tax bracket is above 28%, then my save additional money in this "Gold up" scenario.
* The most extreme example: hyperinflation in which the US dollar continues to be used, but "old dollars" are replaced with "new dollars" at a rate of 10/1 or perhaps 100/1 (or even 1B/1 as in 1914-1928 Germany). So the "new dollar" is now worth the same as the pre-hyperinflation "old dollar"--your gold is still $10k but has a $0.01 cost basis. In effect, your entire $10,000 in gold is now taxed 28%. So you end up with only $7,200. http://en.wikipedia.org/wiki/Hyperinflation#Germany
* However, you will be extremely happy to have the $7,200. Most people will have no investment capital. You should try to hang on to most of your gold, and you need to be very cautions about investments--but if you are clever, you should be able to sell some of your gold and find profitable investments at pennies on the dollar.

SITUATION 2b: "Gold Down".

* Your $10k of gold goes down to $5k. (Impossible in my opinion, but just an example.)
* Your short goes up $5k. You close the short and buy $5k more gold.
* You now have a +$5k "earned income" tax and a -$5k "collectibles" deduction.
* This leaves a big question. Can 'collectible' losses be used to offset non-collectible gains? Or do you now possibly have a "collectibles deduction" which you might never be able to claim?
* Assuming that there is a way to claim the "collectibles deduction"--this scenario saves tax dollars for people with a low tax bracket, and costs extra for a high tax bracket.

2c. Conclusions about using short-selling to freeze the prices of assets.

* I will be asking my tax preparer if a "collectibles deduction" can be used if there are no "collectibles gains"? If so, then I am hopeful that the above "price freezine" strategy may be feasible. With each rebalance, sometimes you will save and sometimes you will lose on the taxes. I think it is wise to be pessimistic and expect a net cost over time of -10% for using this strategy. This seems a reasonable cost for total insurance for an unlimited amount of time.
* Even if there is a serious problem with the 'collectibles deductions'--this might be overcome by going long-short on a combination of physical gold and gold mining. Then you never need to sell any physical gold. When gold+mining go up, you only sell the mining. No 'collectibles' tax.
* My calculations were done hastily. I will recheck them later. I welcome anyone to report any errors.


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3. ARE OPTIONS BETTER THAN SHORT-SELLING FOR THE PRICE-FREEZING OF ASSETS?

If anyone believes that options are better than traditional short selling--for anything--I will be interested to hear this. But please try to explain in a simple non-jargon manner because I never traded options.

I have come across discussions about whether or not to buy short options to hedge against the downside risk of gold assets. But I do not understand why they might want to do this, instead of simply shorting GDX...? If anyone can explain this simply, I will be interested.

Thank you anyone for your help.
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