Short Selling Is Tough Business
bloomberg.com
bloomberg.com
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-...
Well, I bought it! :) I was rooting for her during the episode.
[0] https://www.imdb.com/title/tt7909184/?ref_=ttep_ep3 [1] https://www.forbes.com/profile/fahmi-quadir/
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.
Are you questioning the mechanism by which it operates? If you raise borrowing costs for a company it hurts them and the ones already at the margin may fold.
If it was that common, seems like it would have been easy for you to just list a few dozen examples instead of handwave it away.
How is someone supposed to prove that in a specific case? It would be the case for a company that failed by a specific margin whose total borrowing costs were increased by more than that margin. Which requires speculating what their share price would have been in the alternative, calculating the resulting effect on their contemporary borrowing cost (which data is available where?), then evaluating their entire business to determine how much additional capital they would have needed to survive.
It would take hours to calculate and be subject to unlimited debate about the reasons and margins by which they failed.
But if you really want an example based on pure speculation, Kodak. They made their share of mistakes but if it had been easier for them to raise funding to compete in digital markets once they changed course they might not have ended in bankruptcy.
And I still haven't heard any argument as to the flaw in the general principle.
Well yes, but that's the problem. If you issue new shares when your share price is lower, you get less money and it may not be enough. You can't just sell an unlimited number of shares, each one dilutes the others and at some point no one will buy them. And all the other lenders rely on your ability to issue new shares to pay them back if it comes down to that, so they won't lend to you if your share price is too low, or will demand interest rates you can't afford.
> Instead, it is pretty clear their business was dying and they had no way to compete against larger tech companies who could provide a better product with cheaper costs to consumers.
They could have at least been GoPro if not the company supplying the cameras in half the phones on the market.
Kodak was a hot mess. Even raising a ton of money couldn’t have saved them from their incompetence. If they didn’t have the vision to see digital cameras, what makes u think they could dig themselves out of the hole they were in?
As one example: they could show a specific company that violated its margin constraints as a result of short selling pressure, which resulted in an unplanned margin sell, that forced it to sell assets at firesale prices, that triggered a liquidity spiral resulting in material harm. You could see this in a financial institution with a weak balance sheet that is forced to unwind long/illiquid positions.
(This is why the SEC banned short-selling of financial institutions during the GFC; the ban lasted about three weeks before it expired.)
Another mechanism would be short selling triggering a bank run, as debtholders & counterparties see a falling share price and think that signals a weakening balance sheet.
It may take hours to calculate but it seems like the kind of thing that academics, journalists, and aggrieved CEOs would have already done the legwork on. A few hours to publish an academic paper or write an article for Bloomberg isn't much investment, after all.
I'm not aware of any even theoretical models about how short-selling hurts non-financial institutions in material ways. Most corporations are primarily debt financed, not equity financed, aren't they? The historical debt-to-equity ratio of the S&P 500 is 1.7, I think.
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.
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.
If you take the notion of “ongoing concern”, then there is a good argument for this thinking.
I have no problem with high risk firms being shorted. Too many times they should not have gone public.
> 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.
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.
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.
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.
You missed out the last part of that, which is "and investors pay 1 dividend". Investors as a class receive 1000 dividends on net. It all just nets out.
> If the company goes bust, all 1001 shares have lost their value.
And the person who sold a borrowed share will have gained money. The net change across the economy is the value of 1000 shares, not 1001 shares.
> If there's a shareholder lawsuit with a payout, there will be 1001 claims
This usually doesn't happen, but when it does, it's a paperwork error, and an artifact of the fairly archaic way share ownership is recorded in the US. It's not inherent to the system, and it doesn't tell you anything about how short selling works in principle.
You can make a lot more money, much more quickly and with far less risk, squeezing misplaced shorts. There is a lot of capital in the markets scanning for accumulations or nonsensical shorts.
That's one of those ideas that looks kinda of plausible on paper, but doesn't really work in the real world. There's just no real evidence that this is a thing that actually happens, and the people who complain the loudest about it are invariably not victims of it.
The current standard-bearer for the "shorts are evil and make people fail!" camp seems to be Musk right now, and there is absolutely zero evidence to support this in the case of Tesla. None of Tesla's issues (with funding or anything else) can be traced back to people shorting the stock.
(Well, Musk's strange "taking Tesla private" tweet may have hurt Tesla's ability to raise funding, and perhaps that was part of some sort of incredibly ill-advised response to shorts, but even if so, the cause of Tesla's issue there is Musk, not short-selling per se.)
> It's not exactly a moderating influence.
On balance, overall, it is. There's extensive evidence of this. For example, China has a list of stocks which you can't short, and when stocks are placed on this list, their volatility increases, even controlling for other factors.
Can you explain what part of it doesn't really work? It seems kind of odd to ask for evidence of something which is a mathematical formula. If shorts reduce the share price by X before you sell Y new shares then you consequently have X times Y less new capital than you would have. Is the argument supposed to be that shorting the stock doesn't lower the stock price?
Granted this doesn't always matter. If a company is not trying to raise funding, what does it matter their cost to raise funding? But sometimes they are.
> On balance, overall, it is. There's extensive evidence of this. For example, China has a list of stocks which you can't short, and when stocks are placed on this list, their volatility increases, even controlling for other factors.
I can see the argument for it can be, which goes like this: Buyers are overly exuberant so people take out short positions which keep the price from going too high. Then the news is middling and the stock falls somewhat, but the shorts closing their positions keep it from falling more as they buy back shares.
But that's assuming the shorts were right. If they're wrong they push the price the opposite of the way it should be going and when the news comes it snaps even harder the other way.
Counterexample: It turns out that planes can't fly! This is easily demonstrated by reference to the standard formula for calculating buoyancy, F = V x (d1 - d2) x g, where F is the force lifting the plane into the air, V is the volume of the plane, d1 is the density of air, d2 is the density of the plane, and g is the force of gravity. A moment's research shows that a Boeing 747 is heavier than the equivalent volume of air, meaning F will always be smaller than 1.
QED, planes can't fly. The fact I can hear one flying overhead right now is, I admit, evidence I may have missed some other factor, but we don't need evidence to evaluate the truth of mathematical formulas, right? :)
In other words: Just because something is A factor doesn't mean it's a relevant factor, or isn't overwhelmed by other factors. And we have zero (literally, zero) evidence that short selling is a factor in the ability of firms to raise funds, or in their cost of funds, once we control for other factors. And we have plenty of examples of firms targeted by short sellers who have raised funds on favourable terms.
> If they're wrong they push the price the opposite of the way it should be going and when the news comes it snaps even harder the other way.
Right, but again, on balance, this effect ends up being drowned out by other effects. You've made a great stab at an explanation for something that isn't really happening, so doesn't really need an explanation.
> They see it as a noble but misunderstood calling.
No. That's what they claim. That's the PR that short sellers sell. Shorts like the longs love money and are in it for the money. Nothing noble or sinister. Nothing good or bad. Just money. And that's what stock markets should be.
> Say what you want about Bill Ackman, but Herbalife does kinda seem like a pyramid scheme.
Too bad Icahn and others with a larger bank accounts believed otherwise.
> I don't doubt they would probably also do really well as investigative journalists.
Almost every short seller loses money. Ackman lost money on his HLF short.
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.
Being a short seller is like playing a game on hard mode. The bias of most market participants, sell-side analysts, self-promoting CEOs, and frauds are to the long side. Being net long is the only way to stay in the game over decades like Chanos has.
Chanos has been short TSLA for 4 years, and that's only been possible because the fund is net long [1]. The only reason he probably hasn't shut the short-only fund is because clients who allocate to it are probably hedging other long exposure they have allocated to other managers.
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.
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.
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.
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.
[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.
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.
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.
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.
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 $11. I lost my entire option bet, oh well. Lession learned.
The last time I thought of buying puts was a month ago when Tesla was at 350$, 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.
As Chanos likes to say: "I've seen more stocks go to zero than infinity."
Yes, but the point is that almost breaking even on short bets can complement your long bets in a synergistic way. Because the returns are helpfully uncorrelated. It probably takes some math to really appreciate, but I can kind of see it.
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.
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.
Short APPL, pay your taxes, wear sunscreen.
†I am not a lawyer. This is not legal advice.
I'll give you 10 to 1 odds, up to 10K.
I have no idea how important the disclaimers really are, but they are definitely popular. Maybe just paranoia.
Edit: it was funnier before you edited it and made it more serious...
It's the same CYA reason that people will respond to a question about law with "Here's what the law says, but I am not your lawyer and this is not legal advice".
I don't know if investing is the same, but that's the answer for lawyers.
The CYA stuff makes a lot more sense in light of that.