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-- Posted Monday, 23 June 2008 | Digg This Article | Source: GoldSeek.com
Rick’s Picks Monday, June 23, 2008 “Phenomenally accurate forecasts” Short sellers on the New York Stock Exchange set a new record in the first half of June, amassing a total position of 17.6 billion shares. If that sounds impressive or even especially bearish, don’t be fooled. In theory, at least, every one of those shares could have been shorted by traders and investors who are quite bullish on stocks. Actually, most short positions are initiated not by bears, but by institutions and floor traders seeking to extract profits from essentially riskless hedge positions. Two hedges commonly used are “conversions” and “reverse conversions.”
Let’s take a “reversal” in Google as an example. With the stock currently trading $548 per share, you could lock in the three-sided reversal by shorting 100 shares of stock, shorting a September 550 put for $40 and buying a September 550 call for $39. If you work the numbers, you’ll see that no matter what price Google is trading on September 19, when the options expire, your nominal loss on the position would be $100. Let’s assume the stock is trading for exactly as much then as it is now, $548. You would have no gain or loss on the stock, but the put that you’d shorted for $40 (i.e., $4,000) would be worth $2 (i.e., $200), since the option would be $2 in-the-money. Your net gain from the sale of the short put would therefore be $3,800. But the call for which you had paid $39 (i.e., $3,900) would be worthless, so you would have lost that entire amount. Your net loss on the three-sided position, then, would be $100. If you were to work the numbers with Google trading for, say, $485 come September 19, you’d find that your net loss would still be $100.
So why would anyone want to use such a strategy, locking in a certain loss –in this case, of $100? Answer: To generate interest income on the short stock. Remember, the position is essentially riskless no matter what happens to the stock, and you took in $54,800 of someone else’s money when you sold 100 shares short at the outset. If you had invested that money in risk-free paper at the current Libor rate of 2.40%, you would have reaped interest income of about $350 over the three-month life of the options. Your net gain on the position would therefore be $250, equal to $350 in interest income less the $100 position loss. That would be further reduced by the amount of any dividends paid by Google during the period, since those dividends would come out of your pocket. But because Google pays no dividend, the entire $250 of interest income would be yours to keep. Not bad, considering you used someone else’s money to make that money.
Betting on a Crash
And that’s why we shouldn’t get too excited about short interest figures, even when they soar to new record highs. To be sure, bearish bettors will have stepped up their short selling lately, given that the U.S. economy and stock market are more vulnerable to a crash than at any time since 1929. Moreover, those betting that the market is headed for a fall are bound to cause breathtaking short-covering rallies as the bear market intensifies over the next several years. But there is nothing significant per se about the fact that total short interest is nearly 18 billion shares. Nor should we be surprised to see that number climb as hedgers and arbitrageurs increasingly dominate the action on the NYSE and other exchanges. There are no longer any long-term investors in the game, the game itself having become little more than an interest-rate play.
Like the put-and-call ratio, short interest is just one more number whose fundamental significance lies beyond the understanding of those traders, investors and technical analysts who would seek to profit from such data. In practice, we can tell far more about the significance of short selling, whatever its extent, by simply watching for signs of panic buying at the beginning and end of each trading day
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Saving America We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and just two days into the competition we’ve received no fewer than four submissions, including one today that argues that Americans need, more than anything else, to get serious about diet and exercise.
Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here. Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month. *** Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in issues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers’ initials will be used unless express written permission has been granted to the contrary. All Contents © 2008, Rick Ackerman. All Rights Reserved. www.rickackerman.com
-- Posted Monday, 23 June 2008 | Digg This Article | Source: GoldSeek.com
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