shorting

in a traditional short sell, or short for…short, you borrow an asset that you believe will decline in value, sell it, then buy it back before it’s due to be returned. for instance, suppose acme stock is at 2300 and you believe it will be at 2000 in one month. you borrow x shares and sell them. then you buy them back in a month and pay back the shares, pocketing the difference if you’re right, or potentially losing money if you’re wrong. note that you also pay a fee anywhere from 0.3% to 3% per year for borrowing the stock.

#math

this can be numerically simplified so that you don’t even have to buy any shares. imagine the owner of the shares simply agrees to pay you p - ain one month, where p is his predicted price and a is the actual price a month from now (plus the aforementioned fee of course). so supposing the owner thinks that the asset will be at 2400 in a month, and you believe it’ll be at 2000. then if you’re right, the owner pays you 2400 - 2000 = 400.

what’s really interesting is that the other party need not even own any shares! any two individuals could simply gamble on the future price in this way.

keeping the asset

but what if you want to short the asset and keep it? in other words, bob is going to give you the asset right now, and you’re going to pay him some amount in the future. what should that amount be? it turns out it’s just 2p - a. if you’re right, you’ve effectively purchased the asset for 4000 - 2400 = 1600, pocketing the 400 savings off its actual market value of 2000. whereas if bob’s right, you’ve purchased the asset for 4800 - 2400 = 2400, which means bob’s lost nothing (you paid him exactly what he thought it was worth) and you’ve gained nothing (save for the shorting fees just like in a normal short.)