Selling Stocks Short as a Christian

[comlogical]

Are the principles of Selling Short not Biblical?

I've been spending more and more time, as of late, researching and studying the stock market. I grabbed a book to compliment my self study. I knew full well that I would eventually run across the topic of Selling Short, but wasn't looking forward to pondering through it.
In the past I've heard from older Christians that they did not feel that Selling Short was a biblical way to trade in the market describing it as "selling stock that you do not own now... and buy it later". They did, however, make it clear that they did not know exactly how it worked.

To make sure we're on the same page (or that I'm even on the correct one), the following is my working definition/example of Selling Short:
when I put an order in to Sell 500 shares of company XYZ at $2 (which first must be shortable in the first place... is this on a per broker basis?) my broker removes $1000 from my account as security. They then take shares from either their own holdings or, if they don't have any, from another client's account, giving them an "IOU" of 500 shares, and sell them in the market (bringing their "pot" to $2000).
When the time comes I "buy back" those shares 500 shares at $1.50. My broker purchases 500 shares for $750, returning them to the original owner. The remaining balance of $1250 is put into my account.


My main question is... are the principles of Selling Short not Biblical?

Trying to break things down into their simplest form a couple questions and points stick out into my mind:

- Is it "right" for a broker to "borrow" shares from a clients account? Do they have their permission or is it part of the account agreement?

- Are their potential negative effects this can have on the market? Is their a scenario that if enough of this type of trading (and borrowing) goes on it can hamper the "balance" of the market?

- Beside the associated risk that I take in the event the stock increases in value, a broker is taking a certain amount of risk by marking a stock shortable. In the above example, say those were the only 500 shares the broker had access to and they borrowed from a client. What if, prior to me "buying back" those shares, the other client sells their shares at a higher price of $2.50.
:::: $2000 - [$2.50*500] = $750 in the pot ::::
Then the value drops down to the said $1.50.
:::: $750 - [$1000 security + ($2.00-$1.50)*500] = -$500:::
In the end, the broker has paid out of their own pocket $500 more than what was originally "collected". It would be the broker responsibility to take on (risk) more short trading than they can afford to lose (much like, it is my responsibility to not put more money into the market than I can afford to lose).




Thoughts?

[KrozFan]

I don't know tons about short selling, I don't think the broker is on the hook for a loss, I think you are. Maybe your broker would need to float a balance for a time, but if you sell short you are eventually requried to buy those shares back. Is there a time period set for when you need to buy back the shares. You can't hold on to them forever can you?

I don't know that if a broker borrows shares from a client that really has an effect. I think if my broker has borrowed shares I can still sell them, so it makes no difference to me as a client.

It seems to me this would be almost like taking on debt. The borrower is slave to the lender. So from that viewpoint I guess so.

[TheWealthSquad]

Typically in selling short the broker must have shares available to put into your account. Naked short selling (selling a stock short without any shares in play to cover it) is illegal.

Unless you have a sell order in place on your stock most broker agreements allow them to use your shares in selling short. If they cannot locate shares you aren't allowed to sell them short. You can keep them sold short forever if you want but you can't get your "collateral" back until you do sell them. I have sold some short that eventually went bankrupt so technically never bought them back.

Now from a Biblical standpoint, the procedure is legal. Conducted according to the laws it has a minimal impact on the overall stock market. Many people will complain that short selling will cause a stock to nosedive but in many cases short sold stock will cause a dramatic rise in the price of a stock.

For example you sell a stock short at $25/share. Then it proceeds to increase in price to $35/share. Now you have a choice required by your broker. You can either add more money to the collateral or you can buy back the stock at the higher price. If a large number of people have sold it short, you will see a mass of short covering driving demand higher than available supply and a dramatic increase in price.

Short selling is usually riskier than buying a stock. You have a limited opportunity for gain (Current stock price goes to zero is the maximum) and an unlimited potential for loss. I generally prefer to buy LEAP puts on a stock if I think it is heading south.

You pre-pay when you borrow the stock so it is similar to a debt but not quite. You simply haven't agreed upon the final price yet. I think it is one of those subjects that really depends on the person's personal beliefs if it is moral or not.

BTW Market makers are the ones who take the risk you mentioned about a limited pool of shares. Thats one reason they limit what can be sold and how much. They take the same risk in regards to put and call options as well.

[clydewolf]

So is a short seller:
- an oportunist?
- a speculator?
- a lender?
- an owner?
- a gambler?
- a borrower?
- an invetor?

[tim_v]

Are the principles of Selling Short not Biblical?

- Beside the associated risk that I take in the event the stock increases in value, a broker is taking a certain amount of risk by marking a stock shortable. In the above example, say those were the only 500 shares the broker had access to and they borrowed from a client. What if, prior to me "buying back" those shares, the other client sells their shares at a higher price of $2.50.
:::: $2000 - [$2.50*500] = $750 in the pot ::::
Then the value drops down to the said $1.50.
:::: $750 - [$1000 security + ($2.00-$1.50)*500] = -$500:::
In the end, the broker has paid out of their own pocket $500 more than what was originally "collected". It would be the broker responsibility to take on (risk) more short trading than they can afford to lose (much like, it is my responsibility to not put more money into the market than I can afford to lose).

My understanding is that the broker is very unlikely to lose money because of 2 issues.
1) The broker doesn't loan out all the share they have available so even if some clients sell others would be buying and the shares available doesn't change that much.
2) The right to short can be called. For example, if Fidelity lets me short UAL but then for some reason lots of Fidelity clients start selling UAL and other brokers' clients are buying those shares Fidelity would have less shares available to short. They would then notify me (if possible) and close out my short position. Note that this means even if I expect a company to go bankrupt and it does actually go bankrupt I can still lose money by shorting if the price goes up in between and I am forced to close out my short.

I think short-selling is closer to gambling than investing but then I feel that way about being a short-term trader also.

[TheWealthSquad]

So is a short seller:
- an oportunist?
- a speculator?
- a lender?
- an owner?
- a gambler?
- a borrower?
- an invetor?

Really good question. How do you classify them? Most of them are pretty serious minded individuals. They typically are financially aware and sophisticated. Though many people do get into short selling based on courses they get.

They are positioning themselves to profit when public perception of the stock changes and the stock drops in price. Most people position themselves to profit when public perception of a stock causes the price to go up.

So some are gamblers. Some are investors (though not in a traditional sense). All are borrowers as they borrow the stock though technically they are required to hold funds in store for the value of the stock. So do they own it before they actually buy it?

So a complicated issue regardless of how you look at it.

[4jacks]

I don't know much about the topic.
But from your description (and other peoples replies) it really just sounds unwise, not so much unbiblical.

Unwise, really just meaning risky. But I suppose if it's just a small percent of your portfolio, then swing away.

I don't think it involves anything immoral, your just playing by the rules of a really complicated game.

[comlogical]

Hmm... I thought I posted a response a few days ago... good thing I saved it in a notepad .txt file after writing. Below you'll find my original response.

After thinking it through, the prevailing thought is "unwise". Take a moment and read the "quick analogy" below (part of my original response). There are several instances where such a trading maneuver can go wrong, but that in and of itself does not make something immoral... it just may make it risky, stupid, and/or just unwise.
So when does something become "immoral". Well, simply looking at the two greatest commandments... love the Lord your God with all your heart, soul, mind, and strength AND love your neighbor as yourself... one must ask themself, when I perform any kind of trade, am I taking advantage of someone in way that does not portray love. Until, someone can present a situation where selling short has an adverse affect on other people because of my actions (whether directly or indirectly) I will have to continue to stand that selling short is not immoral... BUT, is unwise because it is taking on unnecessary debt (which happens to be very subjective).


--- original response ---

"Maybe your broker would need to float a balance for a time" KrozFan

That seems to be a much better way of saying it.


"It seems to me this would be almost like taking on debt. The borrower is slave to the lender." KrozFan
"You pre-pay when you borrow the stock so it is similar to a debt but not quite. You simply haven't agreed upon the final price yet." TheWealthSquad

Diving a little bit into my broker's programs there is a Margin Account that entitles you to perform Short Selling. According to their agreement the money used to Sell Short is loaned (I believe regardless of my balance) and interest is paid. I suppose it would depend on the broker, but in this case I would be borrowing shares as well as money.


"Many people will complain that short selling will cause a stock to nosedive but in many cases short sold stock will cause a dramatic rise in the price of a stock. " TheWealthSquad

I've noticed that aspect. In order to even perform a Short Sale, you still need a buyer of the stocks which provides demand which can push prices up. This can act as a catalyst in a situation where there are currently few stock holders (traditional method) interested in selling, "forcing" the stock back out onto the market.



"So is a short seller:
- an oportunist?
- a speculator?
- a lender?
- an owner?
- a gambler?
- a borrower?
- an invetor? " clydewolf

If I understand you correctly, a possible definition of a short seller would be... an opportunist who take a calculated risk to borrow stock with intent to pay back to the lender later.

If I were to make up an analogy on the fly... I live in a community. You have a pile of wood. I want to borrow your wood to sell in the local market. You agree as long as I return the wood when you are ready to sell it, otherwise I owe you the market value of the wood. If I planned properly, I would borrow you wood and sell it at a high price. When the wood market becomes saturated I would purchase the same amount of wood that I borrowed at a lower price and return it to you. This is all facilitated by the community leaders to ensure that you and I are being fair.


So... are the principles of selling short not Biblical?
As such so many things in life are, it truly is a personal conviction. As I learn more in trading I want the Lord to convict me in the ways that he wants me to practice.
With the amount of information I have right now in front of me I can draw a few (maybe temporary) conclusions). It has already been a conviction of mine to stay out of debt (except for a few exceptions... house and schooling {all within reason, what I am able to pay off}). By short selling, at least through my current broker, I am forced to borrow funds. Be it in the form of cash or property.

[gmail]

Short selling is an important price discovery mechanism for the market. It sends the signal to other investors that the stock might not be as solid an investment as they thought. If a stock's price drops because of high short interest that's a good thing; it keeps people from paying too much for an overvalued investment.

The only potentially Biblical problem I see with it is if you don't believe the New Testament allows for any sort of debt.