When people asked, "So, what do you do at Goldman?" At first I'd tell them I was a sales trader in Global Securities Services, a group of 200 professionals. If they asked for more information, my answer would produce yawns and glassed over eyes. Terms like "short selling," "term funding," and "rehypothecation" were laced with a sedative. To keep it simple, most people know that in the stock market you want to "buy low and sell high." Well, in my business it was a flip of that order-it's "sell high and buy low." People, or more specifically hedge funds and crazy rich people, would sell a stock that they felt was overpriced, expect- ing it to drop. Once the price fell, they would buy it back. But here's the thing: They didn't actually own the stock to begin with. That's where I'd come in. I'd lend them these stocks, and they'd pay me a fee, like a rental charge, which was sometimes large, so they could sell them in the market. I borrowed these stocks from my institutional clients, large pension funds and mutual funds, endowments, and insurance companies, who owned the stocks in their portfolios. I stood in the middle of these trades, with hedge funds on one side and institutions on the other, and 1-or, rather, Goldman-would take a cut.
When I explained all of this to my liberal arts friends from Bryn Mawr, they'd look at me like I was playing a pointless video game and ask what the point was. Why would anyone want to short a stock? Some of my clients just felt the stock was over- priced and that there was money to be made in that assessment. Say, for example, XYZ stock is trading at $100 a share. Some hedge funds would research the company and think, based on their earnings and balance sheet, that the stock should be worth only $60. So they sell short at $100 and wait for the price to come down to $60. This wasn't a given - it's like when you buy a stock in the hopes it increases in value, you can't guarantee it actually will. So, if the stock drops to S60, they would buy it back and make the $40/shume difference, minus any fee, and I'd return the stock to its original owner. Short selling is a well-established strategy, and although these speculators don't get it right every time, most get in right enough of the time to post amazing returns to their investors.
For others, shorting stock is part of a larger trade. This happens in arbitrage, when funds buy and sell securities simultaneously in order to take advantage of differing prices for the same asset. For example, in a merger, when one company (the acquirer) announces they are taking over another company (the target), many days or months pass between the announcement of a merger and its completion. When the deal is official, the two companies become one, with the same stock. By buying or selling both the original companies' two stocks at the same time, funds try to profit from the difference between the price of the acquirer's stock and the price of the target's stock-they buy the target and sell the acquirer, during the window between the deal's announcement and the deal's closing and at the end it becomes the same stock.
But you don't have to be a Fortune 500 insider to be privy to the practice. I spot arbitrages all the time, even at Dunkin' Donuts. For a time, there was a great arbitrage on their donut holes. The box of fifty was priced at $9.99, but the ten-pack went on sale for $1.50. So, you could buy fifty donut holes for $7.50 if you just bought five of their ten-packs. You'd end up with the same product but $2.49 cheaper. This is what arbitrageurs do - they're essentially just buying ten-packs of donut holes.
This tidbit is from the book Bully Market by Jamie Fiore Higgins