WEBVTT

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Let's review what we went over
in the last video, and one of

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you all actually commented that
it would be a good idea

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to draw a timeline.

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So I'll draw a timeline.

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Short.

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So we're learning about
short selling.

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And in the last example-- let
me do the timeline where

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things work out well for
the short seller.

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So let me draw the stock
price of IBM.

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Let me make this its--
OK, here we go.

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So let's say that this is-- that
could be our timeline,

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it's by day.

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Let me draw the stock of IBM, it
could look something like--

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that's my y-axis.

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Let's say the stock right now
is at $100, it's trading

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someplace like that.

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And let's say it does
that later, right?

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But we're sitting at this
point right here-- we're

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sitting at, let's
call this day 0.

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So what does the short
seller do?

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So let's say the short seller,
right now-- let me see if I

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can draw his balance sheet.

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So right now, the short seller,
he has assets and

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liabilities.

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His assets-- I won't worry about
collateral requirements

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and all of that right now.

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But usually he already has to
have some assets ahead of time

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for him to be able
to borrow shares.

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But, actually-- let
me give him some

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collateral ahead of time.

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So let's say that he already
has $60 in his account.

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He has $60 of assets on day 0.

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And then this is the day that
he says, you know what?

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I've done my analysis and I
think IBM-- he doesn't see

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this part of the stock price,
I mean, it would

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be great if he did.

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Then you could short
with conviction.

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But all he sees is
the past, right?

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If he did a stock chart he would
just see-- let me switch

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colors-- he would just see this
green part right here.

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He wouldn't see all the stuff
that's in the future.

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But he has a lot of conviction
that IBM is going to go down.

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So what he does is, he borrows
a share of IBM on that day.

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So then on this day he
borrows one share.

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So he has-- let's call
that IBM-- one IBM.

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And he also owes one IBM.

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Right?

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Right after you borrow it,
before you do anything into

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it, you have it as an asset,
and you also owe it back.

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And if you wanted unwind the
borrowing of it, you could

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just give it back.

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But what he does at this point
is he sells this IBM.

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He sells that share and
he gets $100 for it.

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Because that was just
the market price.

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That's what people were willing
to trade IBM shares

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for at that point in time.

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That's day 0.

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Then let's say IBM reports
its earnings, and

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they're really bad.

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And that happened on, I
don't know, probably

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happened on this day.

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IBM reports.

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And the stock tends to
go down, down, down.

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People take a long time
to realize how

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bad the report was.

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And here at this day, once the
stock has reached $50, our

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short seller says OK,
that's enough.

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I don't think the stock's going
to drop a lot more.

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So on day-- let's call
this day 10.

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10 days have gone by.

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Day 10, he decides to cover.

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So going into day 10, this
is his balance sheet--

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let me redraw it.

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So going in to day 10,
what does he have?

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He has $160.

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The $60 he had before, just
by actually working.

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And he owes-- this is his asset,
and his liabilities is

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he owes one share of
IBM to the broker.

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And the broker really owes it to
one of the shareholders of

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IBM who happened to be keeping
the share with the broker.

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And he wants to cover.

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So what he does is, he takes
$100-- no, no sorry, he

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doesn't take $100.

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Now shares of IBM only
cost $50, right?

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So he takes $50 to buy a
share, to buy one IBM.

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So instead of $160, he
now has $110 and he

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has a share of IBM.

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And then what he does is, he
takes this share of IBM and

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then gives it to the brokerage
to pay off his liability.

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So then he's done.

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He's left with no liabilities,
and just $110 of assets.

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So he made $50.

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So hopefully that clarifies it
up a little bit, in that he

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sold here, and bought here.

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It's the reverse of a lot of
stock, it's almost like you're

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acting in reverse time.

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But this was a very good
scenario for the short seller.

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But he very easily could
have made a blunder.

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Let's see what could have been
a blunderous scenario.

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Let me draw a different
stock chart for IBM.

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So let me draw the stock up to
the day in question, and we

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said it was looking something
like this, where it was

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trading right at around $100.

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And this is the day that our
short seller decides to short

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it, and this happens.

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Right?

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He essentially borrows
a share of IBM.

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So he has a one IBM
share liability.

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He sells that share and
he collects $100.

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And then let's say IBM reports
on this day, so this is day 0.

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Now IBM reports, and it's
actually great.

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They did way better than anyone
could have expected.

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So then the IBM shares
skyrocket, and

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they go to this level.

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And at this point this-- and
I'll talk more about short

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psychology and short squeezing,
and all that-- but

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maybe here he's like, oh no,
this is just a temporary blip,

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let me keep holding
my position.

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But then the stock keeps going
up and up and he says oh, this

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is just temporary, it's
going to go back down.

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But at some point, his tolerance
for pain has been

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tapped out.

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And let's say IBM
gets to $150.

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He says, I can't handle
this anymore.

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And I think you're already
noticing a very negative

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dynamic or a highly risky
dynamic that occurs with

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shorts, is that you can lose an
arbitrary amount of money.

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Because what's happening now?

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Let's say he wants to
cover it right now.

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This is day 10 in this
alternate universe.

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So now, what are his assets
and his liabilities?

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Going in to day 10, his asset,
we said, was $160.

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Because he had short
sold, he had $160.

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But he owes one share of IBM.

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For him to unwind this, to pay
back the share of IBM, what

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does he have to do?

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He has to go out into the market
and buy a share of IBM

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at this higher price, at $150.

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So when he goes out, instead of
$160 he has to use 100-- so

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he has $10-- and then he uses
$150 of that to go buy-- $150

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of the $160 to buy
a share of IBM.

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So then he gets a
share of IBM.

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And then he can pay that share
back to the broker and cancel

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out his position.

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And he's left with just $10.

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So in this scenario when
the stock price rose by

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$50, he lost $50.

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So he sold low and then
he bought high, right?

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And the really risky thing that
maybe is apparent to you

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now about short selling
is that his loss

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could have been infinite.

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What if IBM, instead of going to
$150, what if went to $200?

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Then he would have lost $200--
if it went to $200, he would

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have lost $100.

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If it went to $300, he
would have lost $200.

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So his loss isn't just
the amount of the

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original short position.

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It isn't just the $100 or
whatever the original

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price of IBM was.

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It can be an infinite amount,
so it really can kill your

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balance sheet.

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Or really make you broke.

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While when you go in the long
side of things, if I were to

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buy IBM here.

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Let's say I'm the guy that
bought this share from the

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short seller.

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What's my worst case scenario?

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Well the worst thing I can have
happen is that the share

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of IBM goes to 0.

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So my loss is really,
I can just go to 0.

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I won't end up owing someone an
infinite amount of money.

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So short selling, inherently,
because of this infinite, you

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could say downside to the
short seller, right?

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They can lose an infinite
amount of money.

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They have to be really careful
about how they make their

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positions and how they protect
themselves from this

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eventuality.

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And we'll talk a little bit
about things like margin

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requirements and things like
that in the future, that

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essentially make sure-- are
the broker's way of making

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sure that the short seller can
actually-- is good to buy back

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the shares.

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Anyway, see you in
the next video.