Question on Shorting
Apologies in advance if this is a stupid question but genuinely curious.
I've always heard shorting framed as you are taking on unlimited downside risk for a fixed upside potential (i.e. the stock going to zero). I was wondering if it's possible to improve the returns by closing out the short position early and then reopening it as a larger position.
I.e. if you short a stock at $100 and it goes to $0 you've made $100 minus transaction/lending fees.
However, what happens if you short the stock at $100 and then close the position at $90 so you've made $10 and now reopen the short with a $110 position and close it when the stock reaches $80 so you've now made $11 on this second trade and then repeat again and again as the stock falls all the way down to zero.
Interesting way to think about it. One of the most successful short-sellers I know always says ‘only short companies that you think will go to zero’ and ‘always press your shorts when they’re working’. Another wise man calls shorting the ‘fugu of investing’: very rewarding when done correctly, deadly when not.
Seriously , your approach achieves the same thing as just increasing (pressing) all the way down . And yes if the stock goes to zero in a straight line you will make more doing it that way. But you are also piling on that asymmetric risk with infinite loss potential, at precisely the moments that the potential profit in your position are decreasing (because the share price is dropping).
So, not for the faint of heart !
Thanks SB'd
Easier said than done, but yes, pressing shorts can dramatically improve the IRR of a short position. For cyclicals, if you can pick the peaks and troughs (biiiiig if) you can certainly earn a great annual return in stocks that end the year flat. If you have a $100 position and the stock falls 30% do you want to, resize the position back $100 at the lower price?
- do nothing (probably not)
- cover the short? ‘I thought their new business would disappoint, it did and the stock corrected, but now I’m pretty much undifferentiated in my view”
- resize the short i.e. short more until your position is back $100 or more at the lower price? “I thought Enron was a criminal fraud and worth nothing, the offices got raided today and the stock went down 30% but the probability that it is indeed worth zero has increased from 40% to 85% since we have new information about enforcement”
It kinda just depends on the situation -> new info comes out and the market under/over reacts, consider the new price and your updated views - did the risk/reward get better or today (lower price, new info). Generally as the price goes lower the upside risk increases, so most positions will shrink. I usually partially resize.
On a bubbly irrational fad - I am to be small until it rolls over, leaving room to aggressively press once there hype breaks
On some cyclicals, I’m good at forecasting earnings and stock reaction, and can try to pick up 20% as many times as possible in the same name (I’m sad when these are acquired or delist, goodbye golden goose)
overall, I like to think about the capturable alpha of any given idea from the outset - if it’s a big liquid name that will go to zero when it breaks, it’s worth more research labor to nail that. Same for a name that I think will have repeatable earnings dislocations - I’ll build more infrastructure here, especially if there are peers with similar dynamics. Is it a stupid shitco spac claiming to invent antigravity? I’ll short it, but not put in much research time - its obviously dumb and obviously dumb shorts like to moon, incremental depth of work doesn’t present any actionable edge, often it will trade like any other stupid shitco spac.
Finally, the context of the position in the book is considered, especially in market neutral. If you’re paired on a sector, you can’t just press your short - you have to buy the long too and consider factor exposures
Bottom line, like everything - it depends and it ends up inevitably more subjective/intuitive than it feels like it should be - but you learn (or you dont)
Thanks and SB'd.
In regards to shorting stocks that are trading at obviously irrational and inflated prices is there any real way to hedge out the risk of retail investors pushing the stock even higher? Would being short the stock and long the stock's volatility (perhaps purchasing some kind of option straddle) provide any risk reduction?
Also, what about in a case when the stock's irrational valuation is driven by some other security, would it make sense to be long the underlying driver but short the stock or would just reducing the size of your position to a level you're more comfortable be more rational and give you ultimately the same level of exposure (thinking of a Microstrategy/BTC type of situation).
Thanks
There are ways in many cases but they’re usually not good. Obviously stupid junk that trades at crazy premiums usually is too expensive to hedge out irrational upside risk, which is why it still trades at crazy premiums despite being obviously stupid - nobody wants to get gamestopped. You’re better off shorting stuff people think is actually good and you find some reason it’s not (it’s critical that this reason, once understood, actually matters to the longs - if they think the company is going to cure death in 2040…. You’ve got silly longs and unfalsifiable thesis
Thanks and SB'd
When you take this to the limit, it is not possible, as your short position would end up being larger than the shrinking market cap of the company.
Not to mention you're assuming with full certainty the outcome is a zero. It's never a straight line and even if it ends in zero, you will have short squeezes along the way GME-style that will blow up your fund.
Because risk managers are aware of the dynamic above, you would never be allowed to press a short like that.
Not super familiar with shorting - in the question where does the $11 come from ("reopen the short with a $110 position and close it when the stock reaches $80 so you've now made $11 on this second trade")? I would've thought you've made $30 on the second trade (or $10 on the second leg of the trade if you never closed the first short), but realize I'm probably missing something
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