Skip to main content
This Board Has Moved

This board has been migrated to our new platform! Check out the new home page at discussion.fool.com or click below to go directly to the new Board on the new site.

Go to the New Site
Message Font: Serif | Sans-Serif
 
No. of Recommendations: 4
Now I'm understanding why most investors don't sell short individual stocks. When a broker borrows shares for you, he has to make a cash deposit with the broker from whom those shares were borrowed whose interest-rate depends on how hard the shares are to borrow. In turn, your broker charges you interest on the loan he is making on your behalf. At IB, margin-rates are a tolerable 1.88% for balances less than $100k (compared to the abusive 8.5% or so charged at Schwab, E*Trade, etc.) Nonetheless, I was shocked to see that my YTD Net Short Stock Interest was a whopping -$279 dollars. That's a huge cost in barely 40 days for loans on $20k worth of shares. So I've begin unwinding the experiment. (Actually, I started last week, even before I became aware of how expensive trading on margin could be.)

I put the stock shorts on as part of a two-legged income play in which I went long the company's bond and short their common in an offsetting amount. My thesis was that as long as the company didn't file Ch 11, I could collect the coupon and that my losses on one leg of the hedge would be offset by gains on the other. Hence, I'd be market-neural, but collect an income-stream. So much for theory. Here's a specific example.

On 12/09/15, I bought 2 of Scientific Games' 10's of '22 at 76.123 for a CY of 13.1% and YTM of 15.8%. Simultaneously, I sold short 200 shares of their common at $8.34. In other words, I spent $1,325 to buy the bonds, but gained back $1,667 on the short sale, meaning, I had no money in the trade, though I would eventually have to pony some up to cover.

Today, I sold the bonds at 65.844 for a loss of (-$206), but covered the short at $5.19 for a gain of $629, or a net on the trade of $423. I have no idea how to figure my basis, hence, no idea how to calculate profits in any meaningful way which, also, isn't what's important here.

What is important, I think, is that I made a directional bet on the basis of a company's deteriorating fundamentals, and the bet paid off. So it isn't 'shorting' that's a problem, but the mechanics of making shorts happen in the least costly way possible. My conclusion is I need to forget about shorting individual stocks and to focus, instead, on using ETF inverses, where I won't be incurring margin costs.

Final thoughts: I'll probably get out of this experiment ahead by a buck or two or three, which was never the real purpose anyway. I just wanted to see if the hedge could be done. Obviously, it can be done, but I've convinced myself it shouldn't be done. Just too much work, too many moving part, too many uncontrollable costs, too much uncertainties about profits, plus some nasty tax consequences, since short sales --regardless of holding-period-- are taxed as short-term trades.

Arindan
Print the post  

Announcements

When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.