ECO2023 - Stock Market Essay 3

ECO2023 - Stock Market Essay 3 - I presume you have read...

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I presume you have read the first two essays I have written about the stock market. In this note I want to cover at a basic level couple of somewhat advanced institutional points, namely short selling and options. I am confident that we all know how an investor makes a profit if the investor expects the price of a share of stock to rise: Buy shares of the stock and then when it rises, sell the shares for a capital gain. When an investor buys shares of a stock, the investor is said to “be long” in the stock. But what if the investor expects the price of a stock will fall—how can the investor make a profit in this case? The answer is that the investor can sell the stock short, a process called “short selling.” How does this work? Let’s take the case of, say Intel. Suppose you think that Intel’s next chips will be a bust and that the stock will fall from the current price of $30 per share to $20 per share. In this case, if you are long Intel—that is, you own shares of Intel stock—clearly you would sell these shares. But beyond that, you also could sell Intel short. In this case, you would go to your broker, borrow shares of Intel, and then sell the shares. For instance, you could borrow 1,000 shares of Intel stock and then sell the shares. With Intel selling at $30 per share, you would net $30,000 (less any commissions charged by the broker, but let’s ignore these other costs). Because you borrowed the shares of Intel stock from the broker, at some point in the future you have to repay the broker by giving the broker 1,000 shares of Intel stock. Suppose that when it comes time to repay the loan, the price of a share of Intel stock has indeed fallen to $20. Buying 1,000 shares of Intel stock now costs
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ECO2023 - Stock Market Essay 3 - I presume you have read...

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