The best way to short?

[frommi]

I just closed my TWTR trade with a return of around 25%, not bad for 2 weeks. But i was lucky because TWTR has not really moved :). I learned a lot, and i think i have now the answer to the topic.

 

The best way to short depends on the IV of the options of the underlying.

 

When IV is low buying puts is the best option, when IV is high selling OTM Calls with around 40-50 days to expiration. In any other cases its buying an ATM put and selling an ATM call, that is a synthetic short stock, but without the need/cost of lending the stock. Of cause you need a mental stop loss for that kind of position.

[tombgrt]

Well gratz. Always nice to have a short that works out directly. Wouldn't want a twitter short move against me! I have increased my index puts exposure today, plain and simple.

[dpetrescu]

I lost 100% on my CRM long LEAPS put at January expiration last Friday. Cost of insurance. CRM is very overvalued but it is in an industry that is near-bubble valuations. The stock could collapse 90% but if it happens in 4 years I can't reasonably structure put options to make a profit even if I will eventually be "right". A better approach seems to me to just short the stock directly because it is tougher to time the collapse and this defeats the purpose of options.

[dpetrescu]

For shorts, I'm leaning more and more towards negative tides / open drain bathtubs instead of focusing on gross overvaluations. Gamestop GME, for example is a brick and mortar that rents and sells DVD games. It is surviving the fate of blockbuster for now only because games require a lot more time to download than movies and cannot be streamed. This is also true of Outerwall although to a much lesser extent because they operate vending machines. Would anyone want to own these businesses 5 years from now? Just think half a decade ago before Apple when no one would imagine watching movies on their phones over the internet.

 

This seems to be an advantage available only on the downside in markets. Chanos and Buffett have made similar insights about this. Can't remember the exact quote but Buffett has said that if you could have predicted the turn of the century boom in cars, you would be broke because it was nearly impossible to select the winner from hundreds of auto start ups. Best approach would have been to short horses, and showed a chart showing the 80% decline in horse population. Chanos has made comments similar to Buffett and focuses on secular decline headwinds from technological advances.

[ItsAValueTrap]

I lost 100% on my CRM long LEAPS put at January expiration last Friday. Cost of insurance. CRM is very overvalued but it is in an industry that is near-bubble valuations. The stock could collapse 90% but if it happens in 4 years I can't reasonably structure put options to make a profit even if I will eventually be "right". A better approach seems to me to just short the stock directly because it is tougher to time the collapse and this defeats the purpose of options.

 

So what if you had shorted CRM or BBRY way too early?  If you had shorted the common stock, you would have been in a world of pain.

 

Look at the history of famous short sellers who decided to short common stock.  It's ugly and brutal.  Read:

Selling America Short by Richard Sauer

Wall Street Addict by Jim Cramer and Trading with the enemy (by somebody who worked for Cramer)

 

Read up on:

Volkswagen

China Medical

AAMC - http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/88060

etc. etc.

 

I don't know if you understand but... the history of short selling is littered with corpses and there aren't a lot of rich survivors.  This risk management thing is important.

 

*Disclosure:  Shorting CRM via puts but I don't think it's a good short.  There is a wonderful franchise here that somebody else would pay billions for (or maybe even more than several billion).

[constructive]

Look at the history of famous short sellers who decided to short common stock.  It's ugly and brutal.

 

You mean like Soros, Druckenmiller, Robertson, Einhorn, Loeb and many other successful hedge fund managers?

 

I don't know if you understand but... the history of short selling is littered with corpses and there aren't a lot of rich survivors.  This risk management thing is important.

 

::)

[ItsAValueTrap]

1- Let me clarify.  I short common stock.  I would encourage others to look into the history of short selling and to be more careful.

 

2- Be careful about survivorship bias.

 

3- What Soros does is probably fine (mostly macro, different asset classes, etc.).  Einhorn's risk management looks questionable to me.  A lot of people blow up even though they're right.  He could become one of them.

 

Over the years, a number of very smart people have learned the hard way that a long string of impressive numbers multiplied by a single zero always equals zero.

[benhacker]

I'll second value trap here.  I think a lot of mistake from shorting come from the opposing lens of value investing.  Position sizes, valuation probabilities are very very much different (and also critical) in shorting vs. going long only.  You simply just can't wait stuff out the same way.  It doesn't work.

 

I think caution is always in order when it comes to shorting. 

 

ValueTrap,

 

Einhorn's risk management looks questionable to me.

 

I'd be curious to hear your example that leads you to this thought.  To me he seems exceptional in almost all ways (I'm no Greenlight expert, but other than his huge position in NEW which I suspect may have had other intentions, I don't really see him as at all lacking in risk management.)

 

Ackman on the other hand seems pretty bad at risk management (I can't believe he didn't lose all his clients for that HLF short at the size he put it on.  Crazy and stupid.)

[dpetrescu]

I agree that shorting is a lot more risky. Human behavior follows Newtons 1st law of physics, and the easiest thing to do (shortest distance) does not involve being patient and rational. So a company can stay overvalued a lot longer than another staying undervalued. And there is always someone willing to buy an overvalued company (Eg...HP and Autonomy). However, I still think there is an opportunity in predictable declines in certain industries. In 5 years Im as confident that Gamestop will be obsolete as I am that GM or Fiat will be better off than today. I'm just not sure how best to structure that longer term bet. Long leaps puts haven't worked for me so far. Someone here posted a good idea about options combinations but that doesnt work well for 75% decline over 5 years.

[ItsAValueTrap]

Regarding Einhorn, it strikes me that his short positions are too big.  From what I remember they run to a few or several percent of his portfolio.

 

As his hedge fund gets bigger, IMO he should reduce his leverage and reduce the size of his short positions (as a % of his portfolio).

 

I don't know what Ackman was thinking lol.  Too bad I didn't go long Herbalife.  I understood that a short squeeze was likely but the shadiness of MLM rubs me the wrong way (despite being highly profitable).

[Orange]

Even if you are convinced that a stock will burn to the ground, do not short until you at least see some smoke.

 

Find value traps that are struggling now, and determine whether you think the business will keep struggling. Never short good or improving businesses, no matter the valuation. Valuation makes all the difference in picking longs, but the best shorts are worth 0, so figuring out an intrinsic value is irrelevant, it's not part of the process. What's important is finding a borrowable stock that you think will die soon. Whether it be from obsolescence, excessive leverage, poor business model, or fraud, it doesn't matter. If the company stops struggling and makes improvements, that's your cue to take the lick and get out of the trade. If you're shorting overvalued stocks just because of an insanely high p/s ratio, or whatever valuation metric, you have no such cue to know when to cut your losses.