I am suprised when I hear the word short on this board so often.
Is it desirable to try and profit 20%-30% on increased risk?
Is it the desire to teach "Mr. Market" a lesson?
Shorting is deceptively easy to a believer in intrinsic value. The weighing machine always delivers, eventually.
Except, of course, when it doesn't. In reality it's almost impossible to short with a margin of safety. Mechanical issues such as loss of borrow or squeeze can wipe you out. But that's not the only risk. Besides causing temporary pain for a short-seller, a rising stock price can PERMANENTLY cure a company's FUNDAMENTAL ills. An overleveraged company can issue inflated stock and pay down debt (e.g. LVLT). A worthless operating company can use it's overinflated stock to acquire a valuable operating company (e.g. AOL/Time Warner or even WCOM/MCI had management played it right).
Tough game. The temptation is understandable, though, when the market is like this.
Two excellent posts on the risks of shorting!
I know one person that tries to mitigate some of the extreme risks of going short by buying out of the money calls. It's not something I would do, but I thought I'd bring it up.
In early 1998 a Nasdaq rule change forced SIEB to declare a 4:1 split. At that time idiots were piling into any split announcement because "splits always go up". SIEB went from $2/share (split adjusted) to $6 overnight. Absurd. The company was worth $2 and not a penny more. Taking money from the idiot split traders was like taking candy from a baby.
Still, I didn't short. Then, as the split date approached, SIEB climbed further. I finally broke down and shorted at $9. On the day of the split SIEB zoomed to $18+! I was down 100% overnight! Fortunately the madness subsided and SIEB drifted back down to single digits by late summer. They then declared a rights offering, so I ended up short the stock and the rights. Terrific. Fortunately the stock continued to sag and I finally covered both the stock and the rights, booking a 25% profit.
I hated to cover at $6+ since I "knew" the stock would return to $2 eventually. But that "pit of my stomach" feeling from the initial run to $18 was still with me, and I didn't like the way a second short position (the rights) just showed up in my account without me doing anything. Besides, I was getting tired of following the company's every move.
A few months after I covered SIEB reported some good numbers and surged above $10 again. They closed the rights offering (after 3-4 extensions) and put the cash to work, improving their numbers further. By February of 1999 SIEB hit an all time high of $70/share!!! Had I not covered I would have been down 1200%. Talk about a near-death experience!
Fortunately for the shorts who stayed in, SIEB never did anything with their inflated stock. It trades at 2.96 today and even dropped below my $2 target temporarily last year. But a big acquisition with $30+ stock could have changed the story completely.
(((The above is excerpted from my soon-to-be-published book "Shorting for Dummies" :-)))
It is the desire to make profits quickly when the stock is temporarily mispriced. You might recall you were good enough to send me a link to Buffett's trade deficit solution. I consider you a board friend, so I'm not challenging you. Other BRK enthusiasts followed a thread over to the Footstar board (FTS, now FTST OTC BB as of today). I will not mention their yahoo names, but I initiated a "tough love" program to try and spare them a good spanking as they talked a big story about how undervalued FTS was. Big talkers, all of them.
Fact is, it is often much easier to identify stocks whose prices are too high, rather than always seeking undervaluation situations. Of course, to paraphrase Munger's words, stocks often stay irrationally priced longer than the speculator remains solvent, so one must be cautious. But shorting can be very rewarding.
Furthermore, your question hits a nerve with me about the nature of speculating in general. There seems to be something in the psyche that loves a dangerous scenario. Look at the plot of any action movie. Hero puts himself in dangerous situation, resolves situation, and is rewarded as he escapes, having "saved the day." I think there's a lot of that behavior in place in the trading of stocks.
One guy I know very well says the same thing about every position he's taken in the markets when the stock subsequently tanked: "I made a little bit of money ... and I GOT OUT," he says. He always reminds me of an action hero, to his mind anyway. He says this about all the stocks he's owned that have gone south. He never lost any money. Amazing, just repeat phrase in quotations. Anyway, I think it must be hardwired into the brains of testesterone-driven guys. And nothing is more dangerous in the markets than the prospect of a short squeeze.
Also, as it regards posting on the boards, never have I seen so much dribble about the long-term prospects of a company - one that's actually ridiculously overpriced - as from those countering the shorts on the boards. It's as if no stock is ever overpriced for the long haul, according to those who don't care to short and misunderstand the shorts to be driving down the price of their shares. However, as WEB put it, the price you pay determines the return you will get in your investments. Of course stocks get overpriced, so shorting let's one put his money where his brain is.
These are my thoughts on the appeal of going short, posting short, and on the pontificating by the longs about how the shorts are wrong, and otherwise dangerous citizens.
Warren has purchased puts on the S&P 500 for BRK. This would appear to violate three often stated rules by Buffett: 1. No Shorting 2. Not Paying attention to overall values/directions of the broad markets and 3. Placing shareholders' capital at risk by speculating on an event that was less than certain to occur within a particular time-frame.
But he did it anyway. Maybe because he felt the opportunity was compelling and that the potential reward substantially outweighed the risks. Who knows. The bottom line is that in an environment like this you may need to re-think ways of making money outside of the ways you are "comfortable" or have made money in the past. If nothing else with some small portion. If you don't, you may not be "intelligently allocating your capital" - due to "sucking your thumb".