From: sehari@iastate.edu (Babak Sehari)
Subject: Re: Should we limit the shorts life time.
Originator: sehari@vincent1.iastate.edu
Organization: Iowa State University of Science and Technology, Ames, Iowa.
Date: Sun, 26 Jul 1992 22:55:53 GMT


In <2271@gandalf.intel.com> chedley@carthago.intel.com (CHEDLEY_AOURIRI) writes:

>In article <1992Jul26.004109.21389@tfs.com>, eric@tfs.com (Eric Smith) writes:
>>...
>>As a general rule, selling any stock short is a sucker bet, unless you
>>have inside information, which might be illegal.
>>...

>So is buying a stock!!! It is a "bigger sucker's bet" :-)

>OK, fellas, let's put some sense in this discussion on shorting.

>When you buy a stock, you are explicitly or implicitly betting 
>that its price will go up sometime in the future.
>If, for whatever reason, you expect a stock's price to go down, you 
>can take the opposite bet of shorting. That is borrowing some 
>shares, selling them, then buying them later when the price 
>drops to cover your short (ie. return the shares to the lender). 

>Note that short sellers do NOT create new shares, they borrow 
>existing shares IF they can find a willing lender!!!

>Let's not get over excited by news that Mr X or Ms Y is short a huge
>amount of shares on a company's stock.

>As most astute investors know, you want always to balance your portfolio.
>That is, you go long (buy) the stocks that you think are under-priced, 
>and you go short those which are over-priced and due for a down correction
>in your opinion.

>Also, many stock investors practice dynamic hedging: for example,
>they buy long some shares of a company, and short the shares of a 
>competitor's whom they think is weakening.

>And finally, let's not forget the shorts-against-the-box: 
>instead of selling shares, some investors short a stock they 
>already own, in a legal tax maneuver to dodge the IRS !!.

>So, when you hear that Mr. Perot is short $1 Million on Citibank,
>do not jump to conclusions too quickly...

>..CHEDLEY..
>-- 
>..!{uunet|tektronix|ogicse}!littlei!chedley    chedley@carthago.intel.com     
>------------------------------------------------------------------------
>Standard Disclaim: The above statements and opinions are strictly mine,
>and do not represent any company or organization's position.
>......................................................................

I was reading some of the responses to my original article, when I noticed
that several people have contradicted themselves in their response, which
made wonder what are they arguing in the first place!? -:)

However, Mr. Aouriri's response seems to be consistent. To clarify, the reason
why when some one short the stocks the supply of that stock is increased let
us consider following example:

Say there are 10 people who are interested to a stock.  Say the total number of
stocks is 20. Also, let us assume A,B,C,D, and E each have 4 stocks of this
company.  Also assume F and G believe the stock will go up so they want to buy
the stock, and say H and I believe the stock to be overvalued but do not own 
this stock. Finally, J believes the stock to be at fair value.  Now, let's
assume from those who own the stock A, B, C, D believe the stock is either
fairly valued or is going up in the price. However, E believes the stock
is overvalued at this point and is willing to sell his stocks.  So if there
were no shorts, we have E who wants to sell and F and G who want to buy.
This leads to price increase, which will benefit not only E who wants to
sell but also A, B, C, D who already own the stock and potentially, F, and
G who bought the stock.  In this case, those who do not own this company
will not benefit from it.

Now, let us allow short position.  In this case assume B and C deposited their
stock with their broker for safe keeping.  Now, H and I would would short
the stocks of B and C, and we also have E who wants to sell.  Therefore the
effective supply is 3 times as much as it would have been without the shorts.
Nevertheless, the demand for this stock is still constant. Therefore, we have
more seller than buyer, so the price goes down.  Let see, who benefited
from this transaction.  Certainly non of the owner of the stocks, since the
price is driven down, neither the buyers, since even after they buy the price
continues to fall until J gets convinced that the price is under valued and
start to buy.  The only winner here are those who shorted the stock, and who
really are not contributing to the business and underlying company. 

So, It seems that say B and C have left their car with a friend for safe
keeping, however, the friend has rented the car. Now, because of wear
and tear, high mileage on one hand, and the fact that the car is reduced
the need for cars in the market place on the other hand, the price of the
car is lower.
                            
                     With highest regards,
                          Babak   Sehari.