profiting from falling stocks: short selling techniques chris argyrople, cfa concentric investments
TRANSCRIPT
Mechanics of Short Selling
• Crystal Ball says stock is going to drop, how do you profit?
• Answer: Sell the stock “short” before you buy it, then re-purchase the stock later at a lower price
• How do you sell something that you don’t own?
Short Sale Mechanics
Short Seller of IBM Owner of IBM
Lends IBM SharesBuy Stock GetsBack Later Returns Shares Purchased Extra Income
Sells Borrowed Gets Cash Note: Short Sellers Collateralize
Stock in Market for Selling Shares the Shares Borrowed
Benefits & Risks of Shorting
Benefits:• Can Profit from a Stock Price’s Fall• Sell Stock, earning Interest Income
(because you invest cash from sale)Risks:• Borrow can be re-called at any time• No Limit to How High Stock Can Rise
Long vs. Short Portfolio Mechanics
LONG: SHORT:
10% Opening 10% Opening
Neg. 50% 5% Weight 15% Weight
“Double Down” 10% Weight 30% Weight
Neg. 50% 5% Weight 45% Weight
Total Loss Lose 10% Lose 20%
Risk Controls on Short Side
Due to “Double Down” Problem, Shorting is Approximately Twice as Risky as Equivalent Long Strategy
Possible Risk Management Strategies:
1. Mechanical Method: Cover if you Lose a Set Amount Like 30%
2. Completely Diversify & Wait for your “Event”
Idea Generation on Short Side
Areas Over-Financed by Wall Street• In the Markets, the “Promoters” always win
•Venture Capitalists, I-Bankers, Brokers•Company Management, Other Insiders
• Past Fads: •Bagel Shops (Entry Barriers??, Theme
Restaurants (Rainforest, Planet Hollywood)•Fuel Cells, Golf Companies, Roll-Ups, Linux• Internet: Browsers, Push Computing, B2C, B2B•Satellites, etc.
Idea Generation on Short Side
Possible Screening Tools:• High Short Interest (Barron’s etc.)• Huge Increase in Stock Price• Insider Selling• CNBC Factor: All Your Friends Talk About
It• Valuations
• Momentum Crowd: Janus, Pilgrim Baxter etc.
Characteristics of Good Shorts
Good Shorts = Opposite of Good Longs:• Bad Business Model (Give Product Out
Free)• High Debt Loads• Deteriorating Fundamentals (Fading)• Shrinking Fundamentals (Down Results)• Valuations with Room on Downside• Accounting Issues• Bogus Management
Timing on Short Side
Pay Attention to:• Is Stock Price Rolling Over• Cockroach Theory: Are Other Firms in
Industry Blowing Up?• Changes in Accounting Policy• Insider Selling• Float• Lockup Expirations
Timing on Short Side
Don’t Short on Valuation Alone:• Valuation is a Necessary but not
Sufficient Condition for a Short Sale• Example: Short Amazon at $4 billion
Market Value – the Stock Peaked above $30 billion
• What will spur a Change in Valuation?
Technical Indicators
Timing Hints:• How Does the Stock Do on Huge Down
Days in the Dow or NASDAQ?• If it is Strong, what is that telling you?
• Look for Changes in Investor Sentiment• Example: Amazon Investors Changing
Focus from Revenues to Profits
Tax Issues in Shorting
Shorts are Always Short Term Gains:• Short Term Gains are 35% Federal Rate
(for top taxrate) PLUS 12% Massachusetts• Holding Period Doesn’t Matter
• Don’t Cover “Busted Short” – they never resurrect themselves from the dead
• Consider Tax Breakeven & Portfolio Impacts
Short Squeezes
What is a “Short Squeeze”?• Large Percentage of Open Interest is
Short • Short Term: Buyers Overwhelm Sellers
How & Why: • Short Covering – Mechanical Risk Control• Long Holders Recall Borrows to Squeeze
Takeover Possiblities
Always Evaluate Potential Takeovers:
• What is the Risk that your Stock can be Acquired?
• Look at Potential Suitors
• Example: Didn’t Short Corel because RedHat had $20 billion market cap, an operating system, and no applications software
Chatrooms
Should you Pay Attention to “the Chat”:
• There may be good info in Chatrooms as Short Sellers post info to disseminate bad news
• Be Careful, but there can be good info
Read Into Wall Street
Sell Side Analysts Provide Hints:• Examples:• “Peoplesoft priced for perfection”• We initiate XXXX with a strong buy, at
15X 2005 revenue• Conservatively discounted back @
15%• Initiate with a Hold Rating
The Press Release Machine
Too Many Press Releases are Bad:• Be wary when Investor Relations keeps
telling you about the next press release• RedHat: 3 press releases / day for months• RedHat: one time they released the
names of 8 programmers on one of their teams
• Is the Culture Dependent on Press Releases?
Investor Relations & Stock Promoters
Pay Attention to the Company’s IR:• Legitimate Investor Relations Firms:
Morgan Walke, Financial Relations Board
• Morgan Walke doesn’t take options
• Stock Promoters: Get a List of ALL of the companies they have represented
• How many options do they have?• Example: Liviakis Financial – Agribiotech
Unproven Concept Stocks
Don’t Bite their “Hook”:• Needle-less Injection Systems • The Hook: Needle Market is $ Billions• Hook #2: Every Diabetic Will Switch• This company has no competition OR
they are the market leader
Reality:• Research will show tons of competitors• How will they Sell it ?
Beware of Laser Companies
Point the laser at:• Hair: if it grows, then it is a hair
removal laser• Paint: if it peels, then it is a paint
peeling laser• Skin: if it peels, then it removes
wrinkles
Chantal Pharmaceuticals
Chantal Burnison, Founder:• A Doctor• Partner in a Major LA Law Firm• Invented a Skin Cream that Reversed
the Aging Process• Has Patents (costs $6 to pull a patent)• Stock went from $1 to $20• 32 Years Old• Smoking Hot Appearance
Canada & Vancouver
Be Extra Careful with Canadian Stocks:
• Bre-X: Discovered Diamonds in Asia• Can’t Really Verify this Independently• Chief Scientist Fell out of a Helicopter,
BY ACCIDENT• Stock was Still Above $10
Pay attention to the variable that matters: is it the Diamonds or the Helicopter?
Sources of Future Frauds
• Mining Companies Internet Gambling
• Cancer Cures Rollups & Acquis.• Aids Cures• Bio-Terrorism • Bandwidth• New Operating Systems• Encryption• Energy – this could be a big one
There’s Always a Story
• Bre-X: Diamonds in Asia• Molten Metal: Neutralizes Nuclear Waste• Safe Sciences: Cures Cancer• Kendall Square Research: Supercomputers• Biopure: Blood Substitute• Agribiotech: Seeds• PlugPower: Fuel Cells
Pattern? Public Shareholders Get in “EARLY”
Check Out Management’s Past
• Where have they been?• What happened to the stock price?• Did they sell before they left?• Why did they leave ?• Who are they friends with?
• Try to get their “life’s story” – this is generally not scripted