FINA3331-Selling_Short - Selling Short A short sale is the...

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Selling Short “A short sale is the sale of stock that you don’t own with the intent of buying it later at a lower price” Source: Reilly and Brown Selling short is an investment strategy, designed to profit from an expected decline in the price of the underlying security What it involves: Step 1: Borrow the stock from another investor through your broker, sell it and deposit the proceeds into your brokerage account. Deposit at least your own minimum required funds. Step 2: To close the position, buy the same number of shares of the borrowed securities (hopefully at a lower price) and return them to your lender (covering your short position). Max profit is bounded by the fact that prices cannot drop below zero. Max losses are theoretically unlimited since price (at least in theory can reach infinity) The latter emphasizes the need for a good understanding of the strategy before engaging in it. To limit his/her losses the investor can place a stop buy order. Note: Theoretically the position can be held indefinitely. Initial or original margin: Minimum amount of cash or other eligible type of securities owned by the investor that have to be deposited into one’s brokerage account (as set by the Federal Reserve Board (Fed)) before short selling. The minimum amount or value of the securities the investor needs to deposit at time t=0 which we will call own funds is given by own funds =initial margin*(P 0 *Q), where P 0 =the stock price of the security the investor wants to sell short at t=0 and Q= number of shares. At t=0, P 0
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FINA3331-Selling_Short - Selling Short A short sale is the...

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