
Short Selling Is Tough Business - hyperpape
https://www.bloomberg.com/view/articles/2018-09-18/short-selling-is-a-tough-business
======
wgerard
Matt Levine has another article that does a great job of summing up short
sellers [1] (see "Short selling, etc.").

I used to work on a product that tracked short sellers, so I had to read a lot
of press releases and interviews and etc. from short sellers. I definitely
agree with Matt Levine's summary here:

> "One thing I will say for short sellers is that many of them really do
> believe their (standard, correct) claims about their role in financial
> markets: that they make markets more efficient, deflate bubbles, root out
> fraud and delusion, and generally make the world better with their unpopular
> and negative activity. They see it as a noble but misunderstood calling."

And in quite a few cases, they're not wrong - I mean, Jim Chanos is probably
most well-known for his short position in Enron. Say what you want about Bill
Ackman, but Herbalife _does kinda seem like a pyramid scheme_.

It's really interesting, and while the financial benefits are obviously there
it does seem like quite a few of them really just enjoy calling bullshit and
exposing people/corporations for it. I don't doubt they would probably also do
really well as investigative journalists.

1: [https://www.bloomberg.com/view/articles/2018-09-12/banks-
do-...](https://www.bloomberg.com/view/articles/2018-09-12/banks-do-the-
trades-they-want-to-do)

~~~
AnthonyMouse
> they make markets more efficient, deflate bubbles, root out fraud and
> delusion, and generally make the world better with their unpopular and
> negative activity.

This is true when they're shorting Enron or some other fraudulent entity. The
issue is that you can short any high risk high reward play and make money if
they fail. But then enough shorting can _cause_ them to fail, because it makes
it more difficult to raise money by selling new shares or using shares as
collateral. And causing a large undertaking to fail when it otherwise wouldn't
have is obviously not efficient.

It also increases volatility because on one side the existence of the shorts
makes the company more likely to fail, but if the company succeeds anyway or
even just stays the course then there could be a "short squeeze" as the shorts
have to buy back the shares they owe when no one is really interested in
selling, so the share price skyrockets. It's not exactly a moderating
influence.

~~~
wgerard
> The issue is that you can short any high risk high reward play and make
> money if they fail

Or (as a short) you can lose massive amounts of money if they're incredibly
successful - in fact, your losses are actually uncapped.

And anyway, that seems like a good thing - there should be a force tempering
high risk endeavors.

> But then enough shorting can cause them to fail, because it makes it more
> difficult to raise money by selling new shares or using shares as
> collateral.

That sounds like a good thing.

If your company has an appreciable amount of short interest the likely reason
is that the company's overvalued, not that Jim Chanos is colluding with Andrew
Left and Bill Ackman just to bring down your company and profit off your
failure.

Further, I don't know that I've ever seen a mid+ cap company take any sort of
significant hit from short interest where there was _nothing_ to substantiate
the short's claims, and there have been _plenty_ of inverse situations
(companies growing in value even when there _were_ substantial issues brought
to light by a short seller).

EDIT: Actually I take that back, I have seen some - because the SEC brought
fraud charges against them. It's the short version of P&D and it's just as
illegal.

> And causing a large undertaking to fail when it otherwise wouldn't have is
> obviously not efficient.

On the flip side, causing a large undertaking to fail faster when it was
doomed from the beginning is obviously more efficient.

> It also increases volatility because on one side the existence of the shorts
> makes the company more likely to fail

Many people are worried that volatility is _too low_ these days (thus why Feb
was such a big deal), so I'm not sure that's a great argument.

~~~
AnthonyMouse
> And anyway, that seems like a good thing - there should be a force tempering
> high risk endeavors.

The point is that it does the opposite.

Suppose you have a high risk company with a million shares and a would-be
share price of $1000, but 20% of the shares are shorted so the share price is
$900.

Now if the company fails, the total losses to the actual shareholders are 8%
_higher_ even though the price per share was lower because there are de facto
more shares in existence.

Meanwhile if the company succeeds, the shareholders make significantly more,
because there are de facto 20% more shares in existence and the shareholders
paid $900 each instead of $1000, with the shorts having to pay the difference.
Which is why the total (e.g. $900 times 1.2M instead of $1000 times 1M) is
more -- because it's attracting more total investment into the stock by having
the shorts reduce the cost of buying shares today and then heavily subsidize
potential gains tomorrow.

> If your company has an appreciable amount of short interest the likely
> reason is that the company's overvalued, not that Jim Chanos is colluding
> with Andrew Left and Bill Ackman just to bring down your company and profit
> off your failure.

Haven't they tended on average to lose money on shorting?

> On the flip side, causing a large undertaking to fail faster when it was
> doomed from the beginning is obviously more efficient.

True in theory, but is that actually what happens? Large companies rarely do
anything fast. Even when the shorts are right, it's usually months or years
before it all shakes out. And as above, when they're right what they're really
doing is increasing total third party exposure to the loss.

> Many people are worried that volatility is too _low_ these days (thus why
> Feb was such a big deal), so I'm not sure that's a great argument.

People are worried about volatility as an indicator, not because it's a good
in its own right that society benefits from creating artificially.

~~~
wgerard
> there are de facto more shares in existence.

> because there are de facto 20% more shares in existence

Sorry, what? Am I misunderstanding you? How does short selling increase
outstanding shares? It's hard to parse the rest of this given what seems like
a grave oversight.

Once you borrow the shares from firm A and sell them to person B, person B is
the holder of record for those shares now. Firm A doesn't own them anymore -
that's why you have to pay out company dividends to firm A from your own
pocket while you're borrowing them.

Regardless of how they track their positions, the only thing firm A owns is an
obligation from you to give them shares back at some point. There's no change
in the number of outstanding shares.

Or are you talking about naked shorting? Because that's been illegal since
2008 (regardless of whether it still occurs).

> People are worried about volatility as an indicator, not because it's a good
> in its own right that society benefits from creating artificially.

Well, for one: People _are_ worried that volatility has become a good in its
own right - hence the famous "Volatility has become a player on the field"
quote and why the $XIV delisting was such a big deal.

For two: You said that short selling increased volatility. I said volatility
is really low, to the point that some people are concerned it's too low.
Clearly, short selling hasn't had a major impact on volatility.

~~~
AnthonyMouse
> Sorry, what? Am I misunderstanding you? How does short selling increase
> outstanding shares?

Selling short requires borrowing shares. It's the same way that banks create
money. There were 1000 shares, then 200 more were borrowed and resold. The
buyer of the 200 shares have shares, so in practice does the original lender
who is owed a share by the short seller. The IOU isn't technically a share but
for most practical purposes it is. If you want to sell it, it's worth a share.
If the share price goes up or down, so does the IOU price. If the share price
gains $1, the owner and the lender make $1 _each_. If it falls $1, they each
lose $1.

> Firm A doesn't own them anymore - that's why you have to pay out company
> dividends to firm A from your own pocket while you're borrowing them.

Right, which is why it acts like another share again -- the original dividend
is paid to the person the short seller sold the share to but the lender still
gets it too. There are de facto two dividends because there are de facto two
shares.

There are actual differences of course (e.g. IOUs can't vote), but for
questions of exposure to price fluctuations and that sort of thing, it's
effectively creating a new share.

~~~
Lazare
> the original dividend is paid to the person the short seller sold the share
> to

It is not. Whatever side bets people may have with each other may result in
money changing hands, but it's not the "original dividend".

There are still 1000 shares, 1000 votes, 1000 dividends paid, 1000 dividends
collected, 1000 ownership claims on residual assets. The bookkeeping can be
confusing, but there's no shares being generated.

> for questions of exposure to price fluctuations and that sort of thing, it's
> effectively creating a share.

If you and I agree that if Apple goes up at least 10% by this time next week,
I'll pay you $500, otherwise you'll pay me $300, then we both now have
exposure to price fluctuations. How many shares, exactly, do you think we've
created? I'd love to see your math. :)

Just because you have exposure to X doesn't mean you _own_ X, and it certainly
doesn't mean you've created X out of thin air.

~~~
toast0
The company only has 1000 shares, but because the lender effectively has a
share and may not even know it was lent, investors hold 1001 shares. If a
dividend is paid, the company pays 1000 dividends, and investors receive 1001
dividends. If the company goes bust, all 1001 shares have lost their value. If
there's a shareholder lawsuit with a payout, there will be 1001 claims ,
although the company will only be willing to pay 1000, which can be a big mess
for a court to figure out -- see some earlier articles from the same author as
this.

In your case, we've jointly made a wager. I wouldn't be an investor in Apple,
like I would be if I held shares, and would still be, if my shares were lent
out.

~~~
gamblor956
A shareholder who lends their share to a short seller is not entitled to a
claim for dividends from the company. They must get the dividends from the
short seller.

~~~
toast0
Yes, that's what I said: the company pays out 1000 dividends, and 1001
shareholders receive a dividend.

------
kapurs151
The full profile of Jim Chanos (that the article is quoting) is available
here:
[https://www.institutionalinvestor.com/article/b1b00ynrgtn05r...](https://www.institutionalinvestor.com/article/b1b00ynrgtn05r/How-
Jim-Chanos-Uses-Cynicism-Chutzpah-and-a-Secret-Twitter-Account-to-Take-on-
Markets-and-Elon-Musk)

The part that I thought was most interesting was that he structures his fund
as 190% passive long and 90% active short. This way, his short fund (which has
average annualized returns of -0.7%) can still allow him to make a lot of
money.

I like the idea that a short fund can make money if they can beat the negative
of the passive index - so if the S&P returns 10%, and I can have a short fund
that returns -5%, I can use his strategy to outperform the S&P.

~~~
bedhead
I have Chanos' returns since inception in the 1980's. I have talked to Chanos
a bunch. The guy is the biggest enduring fraud, figuratively speaking, in the
investing world. His returns are _dreadful_. There is no money manager in the
history of the world in which his own personal enrichment has diverged so much
from his clients'. The worshipping of him is nothing short of shameful. I
thought we despise the notion of getting rich at other peoples' expense?

Btw, losing less than the S&P is not a strategy but if you think it adds alpha
I won't bother debating. Have fun spending alpha.

~~~
JumpCrisscross
> _His returns are dreadful_

Ursus loses money in up markets. That is almost by design—it’s a catastrophic
hedge inspired by 1987. His headline fund has been profitable for almost every
vintage older than a few years.

~~~
bedhead
The hedge fund? Wrong. I have those returns too. Ever wonder why neither he
nor anyone talks about his returns? It’s not a conspiracy...

It is insane to me. We detest more than anything the notion of the high fee
hedge fund manager who gets rich while his clients lose money, but the world
gives Chanos the biggest pass of all time. This is a guy who has made
something like $1 billion pre-tax and pre-divorce while his fund has just lost
copious amounts of money over any relevant time frame.

~~~
JumpCrisscross
> _The hedge fund? Wrong. I have those returns too._

Chanos has multiple funds. Some of them are designed as catastrophic hedges,
and work accordingly. His other funds are intercyclically up, doing better in
the crisis and early recovery phases and less well in late recovery. If you’re
seeing different numbers, you’re being fed garbage.

------
nodesocket
For me the upside of short selling is not worth the risks[1]. Long term the
market appreciates, so if you are young, wait it out and rake in the annual
average 6% S&P market gain.

    
    
      [1] RISKS
      - Upside is capped to 100%, the most you'll ever make is 100% shorting.
      - Downside is uncapped, unlimited losses.
      - Have to pay interest while you hold the short position.
    

If you really believe in a short position, the only strategy I'd personally
recommend is put options. Limits your loss to the total cost of the options,
and upside is more than 100% potentially.

~~~
bluquark
Put options have their own enormous downsides. You pay a large premium up
front, and you lose everything if the stock either A) doesn't change value at
all or B) collapses later than you predict. Both methods are a rotten deal.

That's quite unfortunate for society as a whole, since it means there are very
few people with the incentive to deflate bubbles and frauds.

~~~
toast0
Put options cap your downside, and cap your time horizon. You can pay the
premium for a very long horizon if you want -- if you think the company is
going to fail all the way to zero, the prices pretty far out of the money are
often pretty low even at 2 years out.

It would be pretty disappointing if the stock kept climbing and then crashed 2
days after the options expired; but at that point you might have given up on
your traditional shorts as well.

~~~
bluquark
It would be even more disappointing if the stock barely moved, and then
crashed 2 days after the option expired. In that event, the put goes to zero
and the traditional short wins the jackpot.

A more abstract way to make the same point is that a put or call is making a
bet about volatility, whereas traditional long or shorting is a pure
directional bet.

~~~
nodesocket
I know this pain. I bought some Jan 19' $10 put options in Kodak right after
they announced their nonsense cryto abomination.

I knew it had run on speculation and was going to come down. The problem was I
timed it wrong. By Feb 7th after my options expired Kodk was trading in the
mid $2 range, down from $11. I lost my entire option bet, oh well. Lession
learned.

~~~
bluquark
I think frequently about buying puts but never pulled the trigger. It's so, so
tempting because in cases like that, you are 100% sure that you're right, and
in fact you actually are right.

The last time I thought of buying puts was a month ago when Tesla was at 350$,
propped up by the "funding secured" claim. It was so obviously bogus and a
sign of desperation. But I was terrified of buying an all-or-nothing lottery
ticket, so I didn't. That one would've been a big winner and now I feel the
pain of missing out. Hearing your similar Kodak story is useful to reinforce
my resolve that I should just stay with vanilla investing strategies.

------
AznHisoka
"The obvious lesson is: Don’t put all your money in a short-selling fund. (Not
investing advice.)"

Why do people always say "You should/shouldn't do X, Y, and Z. But this isn't
investing advice"? It's obviously written as investing advice. What else is
it? Life advice? Casual advice?

If it's not investing advice, don't make such an authoritative claim.

~~~
rootusrootus
Because if you are in a position where you might plausibly give investment
advice, and you make a statement that could conceivably be construed as
investment advice by the authorities, you may find yourself running afoul of
the law. So just like a lawyer making comments about legal choices, you make
it explicit that you're not acting as a professional advisor.

~~~
mehrdadn
Is there any precedent for this kind of short disclaimer saving someone's
legal rear as a defense?

~~~
mikestew
In order for there to be a history, there would first be a few obstacles to
get over: "What are you, stupid? I _said_ it wasn't investment advice. Sue if
you want, good luck finding a lawyer to take the case."

Okay, potential plaintiff found a lawyer who will take the case. It would
still need to go before a judge who didn't immediately laugh it out of the
court room.

After all that, then you might find a court case recorded somewhere. Let us
know what you find.

