Saturday, October the 4th, 2008
Part 1: Short selling
- Let’s say BigWig has 10,000 shares of Apple Corp. (worth, say, $150 each).
- JoeWeasel approaches BigWig and requests to “rent” these shares for a week, for say $50,000.
- BigWig sees this as a good deal, for once JoeWeasel returns his shares, in effect, he’s received $50,000 “for free.” So he says OK, and gives his shares over to JoeWeasel.
- JoeWeasel then immediately sells these shares (at $150 each) and receives $1,500,000 for it.
- JoeWeasel then writes a blog entry about how Steve Job’s cancer has resurfaced (or he had a heart attack or whatever). Once the media picks up on this, there is mass hysteria and panic—and the perceived value of Apple Corp. drops. Consequently, a drop in its share prices follows; so it’s now, say, $100 per share.
- JoeWeasel then quickly buys back 10,000 shares at this new lowered price of $1,000,000 using the $1,500,000 he pocketed a couple of days prior; netting him $500,000.
- At the end of the week, JoeWeasel returns the shares and $50,000 as a renting fee to BigWig.
- JoeWeasel walks away with $450,000 for a week’s hard work.
- In a few days, people realise that JoeWeasel was lying about Steve Job’s cancer, and the Apple Corp.’s share prices correct themselves—returning again to $150 per share. So BigWig didn’t really lose either.
This sort of thing really hurts my brain.