This is an excerpt my most recent newsletter which you should go subscribe to right now. It’s free.
Now let me just preface this next bit by clarifying that I don’t have any idea what I’m talking really. I’m not an investor and I don’t understand the stock market beyond generally that it’s there to make rich people richer and fuck over poor people. Now I must admit that my hands aren’t entirely clean in that – I do own 2 full shares of Disney stock that my mother bought for me when I turned 10 and I think they are worth exactly the same today as they were then and I have no idea how to sell them even if I wanted to cash out and buy a coffee, but that’s my disclosure. Maybe some of you are in the same boat. Besides that noteworthy asset my understanding of stocks comes entirely from watching Billions.
That said I have an ace in the hole that most people don’t have access to. My son Ripley, who turns 11 this year, is a math genius. No really, he won some kind of math contest at his school in Tokyo and everyone was really impressed. Ask anyone. So he and I were talking about what’s going on with GameStop (he’s been actively interested in the Bitcoin news) and when I tried to explain sort of what I thought was happening he corrected me and explained it better, so I thought I’d relay that here for all of your benefit.
A: Buying stock: This is basic 101 stuff that probably everyone already knows. If a stock costs $10 and you buy 10 shares for $100, then the stock goes up to $15 dollars and you sell all 10 shares for $150 bucks, you just made $50 bucks. Similarly if the stock goes down to $8 and you sell all 10 shares for $80 then you just lost $20. Easy math here.
B: Shorting stock: This one always confused the fuck out of me but I think I have a handle on it now. If you think a stock is going to go down relatively quickly buying it would be a bad idea due to the reasons we just discussed in (A). BUT! There’s a way to bet against the stock, which is called shorting it. The way that works is this: Let’s say Jack owns stock in a company called Hills Inc and Jill thinks that Hills Inc is about to fall down and break it’s crown, so to speak. So what Jill does is “borrow” shares from Jack when they cost $10, then she waits some agreed upon time for the stock price to drop, buys them back at a lower price and returns them to Jack keeping the profit. So – using the same math as above, if the stock cost $10 when Jill “borrowed” 10 shares from Jack and sold it at that price she then has $100 in hand, and over the next few days it drops to $5, so she buys 10 shares back for $50 and then returns those 10 shares to Jack, keeping the extra $50 profit for herself. Jill successfully shorted the stock.
Now the trick is, that’s assuming it goes the way Jill wants it to. If instead the price climbs, Jill is in trouble. So, if she borrows 10 shares at $10 and sells them for $100, but over the following days the stock price doesn’t drop but instead rises, Jill still has to return 10 shares to Jack. So if the stock price rose to $12, Jill has to spend $120 to buy those same 10 shares, which ends up causing her to lose $20 in the deal.
Basically shorting a stock is a way to make money off a stock you don’t even own by betting against it. That said, in order to short a stock, you have to have some collateral being held incase things don’t go your way. Which is important for this next part.