Short Sale

Lesson

Short selling is an investment strategy that involves selling borrowed securities with the expectation that their prices will decline, allowing the investor to repurchase them at a lower price and profit from the difference. This strategy is considered risky and speculative, as it involves betting against the market and can result in significant losses if the securities' prices increase instead.

Practice Question #1

Which of the following best describes a short sale?

A) Selling borrowed securities with the expectation that their prices will increase

B) Selling borrowed securities with the expectation that their prices will decrease

C) Buying securities with the expectation that their prices will increase

D) Buying securities with the expectation that their prices will decrease

Select an option above to see an explanation here.

A) This is the opposite of a short sale. B) A short sale involves selling borrowed securities with the expectation that their prices will decrease, allowing the investor to repurchase them at a lower price and profit from the difference. C) This describes a long position, not a short sale. D) This describes a bearish investment strategy, not a short sale.

Terms

Short sale:: The sale of borrowed securities to repurchase them at a lower price to profit from the price decline.
Borrowed securities:: Securities that an investor borrows from a broker or another investor to sell short.
Short position:: An investment position that profits from the decline in the price of a security.
Margin account:: A brokerage account that allows investors to borrow money or securities to make investments.
Margin call:: A demand by a broker for an investor to deposit additional funds or securities to maintain the required margin in a margin account.
Short interest:: The total number of shares of a security that have been sold short but have not yet been repurchased.
Short squeeze:: A rapid increase in the price of a security due to many short sellers buying back the security to cover their short positions.
Buy to cover:: The act of purchasing securities to close out a short position.
Naked short selling:: The illegal practice of selling short securities that have not been borrowed.

Practice Question #2

What is a short squeeze?

A) A rapid decrease in the price of a security due to a large number of short sellers buying back the security to cover their short positions

B) A rapid increase in the price of a security due to a large number of short sellers buying back the security to cover their short positions

C) A situation in which a security's price remains stable despite a large number of short sellers attempting to profit from a price decline

D) A situation in which a security's price declines rapidly due to a large number of investors selling their long positions

Select an option above to see an explanation here.

A) This is the opposite of a short squeeze. B) A short squeeze occurs when a rapid increase in the price of a security forces many short sellers to buy back the security to cover their short positions, further driving up the price. C) This does not describe a short squeeze. D) This describes a rapid price decline, not a short squeeze.

Do Not Confuse With

Long position:: An investment position that profits from the increase in the price of a security.

Practice Question #3

Which of the following is an illegal practice in short selling?

A) Borrowing securities from a broker to sell short

B) Selling short securities that have not been borrowed

C) Buying securities to cover a short position

D) Selling short securities with the expectation that their prices will increase

Select an option above to see an explanation here.

A) This is a standard practice in short selling. B) Naked short selling, or short securities that have not been borrowed, is illegal. C) This is a standard practice in short selling. D) This is an incorrect expectation for a short sale but not an illegal practice.

Historical Example

In the early 2000s, a group of investors noticed that a particular company's stock price was significantly overvalued due to fraudulent accounting practices. They decided to sell the company's stock short, expecting the price to decline once the fraud was exposed. When the company eventually filed for bankruptcy, the short sellers profited from the substantial drop in the stock price.