6 ms·

This article doesn't mention this, but short selling is a fundamental piece upon which many other financial instruments are built, because it allows hedging If

This article doesn't mention this, but short selling is a fundamental piece upon which many other financial instruments are built, because it allows hedging If you take away short selling, you take away many other healthy components of functioning markets. You won't have functioning options markets for example, because market makers can't hedge their positions I'd actually like to see more short selling. Especially in small biotech companies. It is either impossible or expensive to short these shares, so no one does it. Valuations can therefore be sustainably too high -- it's as if these stocks live in a world of lower gravity Having an active short market would also enable all kinds of interesting options trading strategies, and I think smart math-minded people would have a field day

tim333 8y ago
Nothing against shorting but you can write puts and calls without being needing short selling. Calls are naturally written by people holding a stock who don't mind selling some and puts by people with cash who don't mind buying some stock.
- JumpCrisscross 8y ago
  > you can write puts and calls without being needing short selling Put-call parity [1] makes option markets work. It lets anyone to manufacture a put from a call and a short, or a call from a put and a long. This ability to spin up options on demand is critical to options market making. (Source: former options market maker.) Take away shorting and you vastly increase the risk of correcting option mispricing. Given how fundamental options are to other instruments, e.g. convertible debt, this would directly decrease funding options (and increase funding costs) to companies. [1] https://en.m.wikipedia.org/wiki/Put–call_parity https://en.m.wikipedia.org/wiki/Put–call_parity
- nemo44x 8y ago
  Shorting a stock doesn't include the time element of options not to mention the relative lack of liquidity in derivatives as opposed to the equity. Saying that, for most amateurs I'd recommend selling puts than shorting since shorting has unlimited downside risk. Sometimes shorting against the box makes sense if you have the asset in another account and can't sell it there. You could short it in your primary account and then move the shares over which make take a few days locking in a sell price. When the shares arrive in your primary account it covers the short position.
  - dm3 8y ago
    Should be "buying puts" if you replicate a short. It's not a clear-cut situation - in times of turmoil, when many traders are considering a short, the price of options will rise. If the situation then calms down and the price of the underlying decreases steadily, the drop in the option price due to lower volatility will offset a lot of the potential gain. When expressing a trade using options one has a lot more parameters to deal with in order to formulate the risk-reward properly. I'd say it's exactly the sort of thing most amateurs shouldn't be doing.
    - nemo44x 8y ago
      Yeah, meant to say buying a put - thanks! My biggest caution against shorting a stock VS a put is the potential loss. At least with a put your loss is capped.
- aaavl2821 8y ago
  Yes but you won't have those options markets unless market makers can hedge. You need a market maker to be on the other end of those trades, and from what I can tell, if market makers can't hedge then they either won't show up or will demand super wide bid ask spreads to make up for the delta risk I'm not a derivatives trader but have explored investing in options when I was at a fund, and that was my experience looking at options for hard to borrow stocks. For market makers out there -- is that a fair assessment?
deleted 8y ago
[deleted]
totalZero 8y ago
> If you take away short selling, you take away many other healthy components of functioning markets. You won't have functioning options markets for example, because market makers can't hedge their positions I'd say this isn't actually true. You'd hedge your short deltas and let the long deltas ride, prefer to sell delta to flatten risk (in other words charge more when selling puts and pay less when buying calls to compensate for P&L variance), and expect put-call disparities to level out in a slightly different manner. You could also sell well-correlated futures to hedge, or just trade combos and pass the risk off to someone else. Empirically, many of the hard to borrow names are the most well-traded in the options world. When people can't sell short, they buy puts and pass the risk off to a market-maker. Specifically about what I said about put-call parity: In the status quo, if puts are more expensive than stocks, you generally sell a put, sell 100 shares of stock, and buy a call. In the hypothetical world where you can't sell short, if you don't already have long shares then you can't take advantage of the inefficiency. So, put implied vol would trade over, and large banks and other dealers who are already long stock would have an advantage over small shops that don't already have a long shares position. The only real difference is that options markets would be less liquid, wider and less efficient.
- JumpCrisscross 8y ago
  > The only real difference is that options markets would be less liquid, wider and less efficient Which raises costs for new share issuances (by making underwriting riskier), convertible debt (by making it more expensive to hedge the stock component), certain other flavours of debt, acquisitions, et cetera.
  - totalZero 8y ago
    And yet you'd still have a functioning option market, which is the point in question. You don't have to hedge delta in short shares of the underlier in order to deal options. You can hedge out using your long shares, and then do the remainder in a correlated instrument or leave it without a hedge. For a pure market maker who simply buys and sells to earn spread, hedging is a means of managing P&L variance and protecting oneself against negative selection bias. Similarly, you also don't have to hedge converts in options. I'm not sure I understand your point about underwriting. Due to regulations, options don't start trading until several days after an IPO. Options on spinoffs tend to list more quickly, but are delayed as well. Secondary issuances have the advantage of already seeing where the market priced the stock, and are generally small, so there's no need to have a tight options market to hedge them.
andrewtbham 8y ago
Betting against a team is different from trying to rig the game. An unfortunate side effect is that it incentives hedge funds to discredit legitimate companies.
- aaavl2821 8y ago
  that goes both ways though, hedge funds talk their book on the long and short side The difference is that it is generally much easier to make money on the long rather than short side. Stocks generally tend to rise in value, which acts to passively eat away at the returns to shorting. And with shorting you have unlimited downside while your loss is capped with a long position So if you are shorting you are fighting gravity and have to sometimes be more vocal to compensate for that. If it were easier to short stocks, maybe people could make money without being as vocally critical
  - andrewtbham 8y ago
    Most hedge funds don't pump up their long positions... I'm not sure why, but they just don't. Also if you buy puts you can limit your down side.

tim333 8y ago

Nothing against shorting but you can write puts and calls without being needing short selling. Calls are naturally written by people holding a stock who don't mind selling some and puts by people with cash who don't mind buying some stock.

JumpCrisscross 8y ago
> you can write puts and calls without being needing short selling Put-call parity [1] makes option markets work. It lets anyone to manufacture a put from a call and a short, or a call from a put and a long. This ability to spin up options on demand is critical to options market making. (Source: former options market maker.) Take away shorting and you vastly increase the risk of correcting option mispricing. Given how fundamental options are to other instruments, e.g. convertible debt, this would directly decrease funding options (and increase funding costs) to companies. [1] https://en.m.wikipedia.org/wiki/Put–call_parity https://en.m.wikipedia.org/wiki/Put–call_parity
nemo44x 8y ago
Shorting a stock doesn't include the time element of options not to mention the relative lack of liquidity in derivatives as opposed to the equity. Saying that, for most amateurs I'd recommend selling puts than shorting since shorting has unlimited downside risk. Sometimes shorting against the box makes sense if you have the asset in another account and can't sell it there. You could short it in your primary account and then move the shares over which make take a few days locking in a sell price. When the shares arrive in your primary account it covers the short position.
- dm3 8y ago
  Should be "buying puts" if you replicate a short. It's not a clear-cut situation - in times of turmoil, when many traders are considering a short, the price of options will rise. If the situation then calms down and the price of the underlying decreases steadily, the drop in the option price due to lower volatility will offset a lot of the potential gain. When expressing a trade using options one has a lot more parameters to deal with in order to formulate the risk-reward properly. I'd say it's exactly the sort of thing most amateurs shouldn't be doing.
  - nemo44x 8y ago
    Yeah, meant to say buying a put - thanks! My biggest caution against shorting a stock VS a put is the potential loss. At least with a put your loss is capped.
aaavl2821 8y ago
Yes but you won't have those options markets unless market makers can hedge. You need a market maker to be on the other end of those trades, and from what I can tell, if market makers can't hedge then they either won't show up or will demand super wide bid ask spreads to make up for the delta risk I'm not a derivatives trader but have explored investing in options when I was at a fund, and that was my experience looking at options for hard to borrow stocks. For market makers out there -- is that a fair assessment?

deleted 8y ago

[deleted]

totalZero 8y ago

> If you take away short selling, you take away many other healthy components of functioning markets. You won't have functioning options markets for example, because market makers can't hedge their positions I'd say this isn't actually true. You'd hedge your short deltas and let the long deltas ride, prefer to sell delta to flatten risk (in other words charge more when selling puts and pay less when buying calls to compensate for P&L variance), and expect put-call disparities to level out in a slightly different manner. You could also sell well-correlated futures to hedge, or just trade combos and pass the risk off to someone else. Empirically, many of the hard to borrow names are the most well-traded in the options world. When people can't sell short, they buy puts and pass the risk off to a market-maker. Specifically about what I said about put-call parity: In the status quo, if puts are more expensive than stocks, you generally sell a put, sell 100 shares of stock, and buy a call. In the hypothetical world where you can't sell short, if you don't already have long shares then you can't take advantage of the inefficiency. So, put implied vol would trade over, and large banks and other dealers who are already long stock would have an advantage over small shops that don't already have a long shares position. The only real difference is that options markets would be less liquid, wider and less efficient.

JumpCrisscross 8y ago
> The only real difference is that options markets would be less liquid, wider and less efficient Which raises costs for new share issuances (by making underwriting riskier), convertible debt (by making it more expensive to hedge the stock component), certain other flavours of debt, acquisitions, et cetera.
- totalZero 8y ago
  And yet you'd still have a functioning option market, which is the point in question. You don't have to hedge delta in short shares of the underlier in order to deal options. You can hedge out using your long shares, and then do the remainder in a correlated instrument or leave it without a hedge. For a pure market maker who simply buys and sells to earn spread, hedging is a means of managing P&L variance and protecting oneself against negative selection bias. Similarly, you also don't have to hedge converts in options. I'm not sure I understand your point about underwriting. Due to regulations, options don't start trading until several days after an IPO. Options on spinoffs tend to list more quickly, but are delayed as well. Secondary issuances have the advantage of already seeing where the market priced the stock, and are generally small, so there's no need to have a tight options market to hedge them.

andrewtbham 8y ago

Betting against a team is different from trying to rig the game. An unfortunate side effect is that it incentives hedge funds to discredit legitimate companies.

aaavl2821 8y ago
that goes both ways though, hedge funds talk their book on the long and short side The difference is that it is generally much easier to make money on the long rather than short side. Stocks generally tend to rise in value, which acts to passively eat away at the returns to shorting. And with shorting you have unlimited downside while your loss is capped with a long position So if you are shorting you are fighting gravity and have to sometimes be more vocal to compensate for that. If it were easier to short stocks, maybe people could make money without being as vocally critical
- andrewtbham 8y ago
  Most hedge funds don't pump up their long positions... I'm not sure why, but they just don't. Also if you buy puts you can limit your down side.