This chapter is from the book
This chapter is from the book
This chapter is from the book
It is as easy to sell short as to buy long
If you're an experienced trader, feel free to skip this section. For the rest of you, the concept of selling short is an important one. After you begin to trade, selling short will become second nature, but experience has shown that many novices initially have trouble with the concept.
Everyone knows that if you buy something at one price and sell it for a higher price, you make money. If you sell it at a lower price than what you paid for it, you lose money. When you trade futures, you can buy or sell in whatever order you like. You can buy and then sell, or sell and then buy. Whichever you choose, the idea is that the selling price should be higher than the buying price. One question I've often heard is "How can you sell what you don't own?" Well, here's how: A buyer of a futures contract is obligated to take delivery of a particular commodity or—and this is what happens most of the time—sell back the contract prior to the delivery date. The process of selling back, which can be done anytime during normal market hours (assuming the market is not "locked limit down" in those markets with limits, which is a rare occurrence), in effect, wipes the slate clean. People seem to have no trouble understanding that if you buy 200 shares of General Electric stock that you can sell back 200 shares of General Electric stock at the stock exchange. Again, if you buy at one price and sell at a higher price, you make money, and vice versa.
| For example, if you buy soybeans at $8 per bushel and sell them at $8.20 per bushel, your profit is 20¢ per bushel, which is worth $1,000 for a soybean contract. (A penny move is a profit or loss of $50.) If you buy a contract of beans at $8 and sell them back at $7.80, you lose 20¢, or $1,000 per contract. If you buy 10 contracts of July soybeans, you could cancel your obligation to take delivery by selling back 10 contracts of July soybeans. You would then be out of the market, and the difference between the price at which you bought and sold would determine your profit or loss on the trade. |
When trading futures, because you are trading for future delivery, it is just as easy to sell first and then buy back later. Selling first is referred to as shorting or selling short. To offset your obligation to deliver, all you need to do is to buy back your contract(s) prior to the expiration of the contract(s). This process of buying back is known as covering. You "covered your short position" to wipe the slate clean. The purpose of shorting is to profit from a fall in prices. If you believe the price of a particular commodity is going down, due to an oversupply or poor demand, you want to go short. The objective is to cover at a lower price than you sold.
| In the soybean example, if you believe prices at $8 are too high and are heading for a fall, you could go short at $8. If prices fall to $7.80, you might want to cover your position and take the 20¢ profit. A short sale at $8, covered at $7.80, is a profit of 20¢, or $1,000 per contract. Of course, if prices rise and you have to cover at $8.20, you would have a loss on the short sale of 20¢ per contract, or $1,000. "Sell high, buy back low" can be just as profitable as "buy low, sell high." |
Kevin 'Mac,' who leased my COMEX seat, once told me a humorous (and true) story: Kevin traded in the copper pit, as did Al, a big commission house broker. Al was big in more ways than one, and his weight seemed to roller coaster depending on which diet he was on at the time. Diet or not, Al was a big guy, and this was an advantage that would get him noticed in the pit. Al was also a colorful guy who liked to play the horses, but at heart he was a shy man. Still, you wouldn't know it when you saw him in the pit because he moved frenetically and possessed a gruff voice. He "filled paper" for a living, meaning he executed customer orders in the pit.
This happened in the copper market of 1987–1988, a particularly wild time. The day of the stock market crash, the market spiked downward 10¢ per pound, a huge single-day move, to less than 80¢ per pound. (Interestingly, just a few months later, it was more than $1.40 per pound). The market was wild and noisy that day, and Al was summoned to the phone to take a large buy order from a New York client. Al was on one of his diets, and that day he had forgotten his belt. He rushed into the pit, raised his arms to bid for the copper, and his pants fell to his ankles. It was a wild day, but for a few seconds, no one could believe their eyes. Everyone stopped trading to stare at Al's boxer shorts. Al turned as red as the hearts on his boxers. (He had gotten them for Valentine's Day.) Then Kevin broke the silence. As Kevin tells it, he didn't stop to think. It just came out.) Kevin yelled, "Look at Al! He's covering his shorts!"
Now there's a story only commodity traders find funny.