Stocks: Anatomy of a Short Sale

[Recyclersteve]

DISCLAIMER: I have already closed out my trade on the stock I am discussing below and likely may never trade it again, long or short. Therefore, this is meant to be educational, and, for someone so inclined, potentially motivational.

Now onto business...

Here is an example of a short sale using real numbers to show potential risk/reward on this type of stock trade.

This is about Intuitive Machines (Ticker: LUNR). This is a SPAC (Special Purpose Acquisition Co.). These stocks has an absolutely wide ride in 2020-2021, but then the bubble burst. Essentially, you have a situation where a company with no real business operations is looking to pair with and buy an existing privately held company. There were cases before the bubble burst where companies with ZERO SALES were valued at perhaps $500 million, which is clearly a ridiculous valuation. There were over 600 SPACs created in 2020-2021 and by the month of July, 2022 there were zero created. So it came to an apparent end very abruptly. Or so I thought...

On 2/15/23 (W) LUNR was a $10.10 SPAC stock that was typically a very slow mover. It was $9-something or $10-something for essentially the entire prior year. The VERY NEXT DAY it hit $51.00 with no substantial news. I saw it when it was going down and had fallen over $10 from the high. I felt this was a new meme stock like AMC and GameStop a few years ago. I felt strongly it would go down further, but I knew I needed to be prepared in case it went up instead. So I shorted 100 shares on Thursday at $40.56 and had 3 additional open orders to short 50 additional shares each if the stock continued to go up.

The stock went down decently over the next few days and then we had the holiday with the market closed. This was followed by a pretty quiet Tuesday where volume dried up substantially.

Then all hell broke loose on Wednesday.

I saw the stock in the mid-70's a few hours after the open (up very sharply from the close of just $37.89 the day before) and decided to change the limit price on an open order to try and force a fill on another 50 shares. The order (which was good until cancelled) was cancelled by my broker as they ran out of shares available to sell short.

There was no fee to short the first lot as the stock wasn't hard to borrow at the time.

CLARIFICATION: Keep in mind that you have to borrow to sell short. If shares have been loaned out to others already the stock can become hard to borrow. At that point the broker may charge a special fee to the short seller to encourage someone who is long the stock to loan their shares out to the potential short seller. The fee receipts are often split between the brokerage firm and the party who owns (long) the stock.

Suddenly, on Wednesday, the fee went from zero last week to an UNBELIEVABLE 450% (four hundred fifty percent!!!) per year. I was absolutely floored. This is approximately 1.25% per DAY. Wow!

When I say all hell broke loose on Wednesday, I mean it. The stock closed at $37.89 on Tuesday and hit an incredible $136.00 on Wednesday. It was up OVER $98 A SHARE. Remember, I wanted it to go down, not up. Oh yeah, to complicate matters, my broker cancelled all 3 open orders I had to short more shares. I was stuck!

At one point on Wednesday my unrealized loss (because I still had a position in the stock) was over $9,500 on just 100 shares. I had the buying power to short about 2,000 shares, If I did that, I'd have been down close to $200k and possibly had to take out a mortgage on my paid off home. Yikes! The wife would have said "I told you so" so many times that it would have been very painful for me.

After Wednesday's peak of $136.00 LUNR fell sharply and closed the day at $81.99 with very heavy trading volume. Even at the end of the day (after a big fall) I was still down over $4k.

By Thursday I was fully expecting that the technical (charts) damage would result in another down day. In very early trading LUNR was up to $97.00. As early at 9:47am EST it had fallen to $71.90. There were no real sustained rallies at any time during the day on Thursday.

Finally, in the last few minutes of the day I covered (got out of) my short sale at a mere $19.56 a share. Profit was 107% in just one week-- Buy at $19.56 and sell (short) at $40.56. Even after deducting interest charges this is more than a double in just one week.

I'll take it! Over $2k in profit in a week with perhaps 2 hours total work is well worth it! This is a great example of why I love selling short and have done it likely several thousand times over the years. Some could argue that I was losing $9,500 before I ended up with a profit of about $2k and that isn't a good risk/reward ratio. Well, it depends on how you assign the probabilities to each. In essence, do you have the stones and buying power to hold onto a big loser hoping it will come back?

Thoughts and comments?

[Robarons]

Well that was quite the roller coaster. Glad it worked out for you. Love the detailed mindset and thought processes going into a trade like this.

With that being said that is why I stick to Put contracts. Yes this security does not have options, but thats a sign to me if options arent traded then I should not either in times of high volatility per my trading style. And even if options were available they would have been crazy priced.

[Recyclersteve]

Do you buy long puts or sell naked (short) puts?

I’ve sold some naked puts before to collect premium. If/when the stock is put to me, I then sell a covered call to collect yet another premium. It seemed to work reasonably well. I wish I could have the ability to sell naked options in my IRA. Oh well…

[NiBullionCu]

What was the potential for the Broker to 'Margin Call' when you were down $9,500?

or was your account 'flush' enough that it was covered already? (Does the broker put a 'hold' on your funds to match the margin call?)

[Recyclersteve]

What was the potential for the Broker to 'Margin Call' when you were down $9,500?

or was your account 'flush' enough that it was covered already? (Does the broker put a 'hold' on your funds to match the margin call?)

I was covered with plenty of cash. This could potentially be painful for some cutting things tight.