Shorting, or short selling, is an investment strategy to speculate on a share price decline. This means that an investor appreciates his/her investment when the price drops. However, theory is something completely different from practice and therefore, we have prepared several specific examples for you.
When to short?
The process includes an investor giving an instruction to short sell if he/she believes that the price of the financial instrument is going to drop. Investors use shorting for speculation or hedging. Speculation is used to capitalise on a potential decline in a specific security. The other option is hedging, which is used by investors to protect profits or mitigate losses in securities or portfolios.
How does shorting work?
In short selling, a position is open by borrowing a financial instrument the value of which is supposed to decline according to the investor. The investor subsequently sells the instrument to a buyer for a market price. Before the borrowed instrument has to be returned, the trader makes a commitment that the price will continue to fall and the instrument may be repurchased at a lower price.
How to profit from shorting?
In order to be successful in short selling, you have to know specific situations, which we will illustrate on the following examples.
Selling WTI crude oil contracts:
If an investor short sells futures for WTI crude oil for USD 40.48 per barrel on 9 July 2020, the subsequent purchase of the instrument for USD 39.24 per barrel on the same day would bring a 3.06% appreciation of the investment. At an investment of USD 10,000, the investor would earn USD 306 on a single trading day.
Selling silver contracts:
If an investor short sells silver contracts in the amount of USD 10,000 for USD 19.03 on 9 July 2020 and subsequently buys the same number of contracts for USD 18.5, the initial investment would appreciate by 2.79%. At a subsequent purchase of silver contracts with an initial investment of USD 10,000, the investor’s profit would be USD 279.
Selling Netflix shares:
An investment in the shares of Netflix Inc. through short selling for the selling price of USD 443.22 per share on 11 June 2020 with the subsequent repurchase of the shares for a market price of USD 412.54 per share on the same day would result in a 6.92% appreciation. If an investor makes an investment of USD 10,000 the investment will generate a profit of USD 692.
What are additional shorting expenses?
Short selling is only done through margin accounts and interest on shorting thus may add up over time. Dividends represent other additional expenses. A short seller is responsible for the payment of dividends arising from short selling of shares of the entity from which the shares are borrowed. The seller also has the responsibility for share distribution and bonus share allocation and issue, which will result in additional expenses for the investor. Last but not least, additional expenses include expenses of received loans and borrowings.Go back