Covered writers have a hand in options trading without taking on all of the risk. They sell options on securities that they already own. This way, when the purchaser of the option is ready to exercise it, they already own the security and don’t need to go buy it at whatever random price it may be. They make money by charging premiums that people are willing to pay, because they're confident in what they think a stock will do. Otherwise, they wouldn’t buy the option in the first place.
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Finance: What are short cover and squeez...7 Views
finance a la shmoop what is short-covering
and squeezing the shorts hmm alright ever see anyone walk uncomfortably out
of the target changing room wearing something the clothing designer never [Man wearing tight clothing by changing room]
intended to fit onto that body yeah that would be squeezing the shorts in in Wall
Street speak the term is kind of related a given stock has a float of say a
hundred million shares and averages trading of three million shares a day
well there's a big hedge fund that's convinced the company's cancer curing [Woman gulps a pill]
drug will actually only turn the users toenails bright green and all of this
will come to light soon the stock will sell off big so they shortened short and
short recall that short selling is when an investor borrows stock betting that
the stock will go down in price and then sells it so yeah that's how it works
they essentially borrow securities from the brokerage with whom they've set up [Stock transfers from brokerage to hedge fund]
the short selling arrangement those shares get sold at whatever price
they're trading out at the time that the short sales happen the hedge fund then
waits until the stock falls to its target price hoping that it actually [Cancer B Gone stock price falls]
falls and doesn't go the wrong way at which point it then buys back the stock
more cheaply delivering it back to the brokerage and booking what is you know
hopefully a hefty profit right so they'd shorted it a hundred and then it falls
to 80 and they buy it back and make twenty bucks a share but things don't
always work out according to the best laid plans of hedge funders and men so
cancer begun stock climbs despite the hedge fund having bet that it would go [Cancer B Gone stock increases]
down well in horror the hedge fund watches as the stock climbs from 80 to
82 to 85 to 90 with the fund all the more sure it's worth 10 bucks a share
after continued shorting of more and more and more shares betting on the [People in meeting looking unhappy]
downfall of cancer be gone while the hedge fund wakes up in more horror one
morning to read the cover The Wall Street Journal which says the drug [Man reading newspaper]
actually works so the CBG shoots suddenly to $200 the
next moment leaving the hedge fund now with an average short sale price of
around 85 bucks a share the hedge fund is $115 a share in losses now that's per
share times the 10 million in shares it shorted and remember it
only trades 3 million a day on an average day that's three days and change
of short position on this stock the loss on this short has wiped out all the
games for the year of the hedge fund and worse the stock now has virtually [Stock price rises]
unlimited upside as cancer curing you know is a thing
so the hedge fund is squeezed why squeezed well it's short position is [Man squeezes hedge fund water bomb and it pops]
squeezed because now it absolutely has to buy back the shares at the $200 plus
price and it has to buy him back because the odds of this stock Falls or goes
down with all the positive headlines coming from journalists all around the
world about cancer being cured well pretty low right stock probably going to
300 400 who knows but it's going up so the hedge fund will have to capitulate [Man giving speech on stage]
that it was wrong in shorting in the first place and all of its competitors
know this fact as they carefully track the short position on the stock noting
that some 50 percent of the hundred million total shares or 50 million
shares that were floating were in fact short enormous short position like this
one hedge fund wasn't the only one betting it would fall so being the
kindly loving people that hedge funders are the competitors will be buying the [Competitors give money to brokerage]
snot out of the stock for a while bidding to 20 to 30 to 40 until enough
volume and shares transacting passes so that the hedge funds will have covered
their shorts meaning the guys who shorted it at a hundred bucks have to
pay to twenty to thirty to forty whatever the price is to unwind their
shorts before the stock goes the 300 400 500 and bankrupts them that's getting
squeezed that's how short squeezes work and
punishes hedge funders for ill-timed bets that are wrong and yeah you don't bet [Hedge funders sitting at a table]
against a curing cancer at least hopefully not in our world the position
there in those shorts being SQUOZE is uncomfortable like this uncomfortable [Man in tight pants in a changing room]
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What's the long and short of short sales and shorting stock? Hit play to find out.