Tuesday, August 28, 2007

Borders Reports Quarterly Results Today

Shelf Awareness reports this morning that 20%--that's one in five
--shares of Borders are currently held by short sellers.

For those of you not familiar with the term, "selling short" refers to a stock strategy in which an investor, who does not own the stock, believes that a company's stock will decline in price, rather than increase. In order to take advantage of this insight, the investor "borrows" shares from an existing stockholder in order to sell them.

The short seller's plan is to sell the borrowed stock today and then wait for the price of the company's stock to fall. When (and if) the price falls, the short seller buys back the stock at a reduced price in order to return the borrowed shares to the stockholder. The difference between the price he sold the stock at and the price he buys the stock back is his profit.

This is among the most dangerous stock strategies because, if the short seller is wrong and the price goes up instead of down, the short seller's liability has no limit. If he waits too long to buy the stock back, his losses can be astronomical.

As an aside, there is a less risky (but more expensive) strategy. Instead of borrowing the stock, the short seller can purchase a "put," an option that gives him the right to sell the stock at a certain price by a certain date. He is then "covered." If the stock goes down as expected, he can exercise his put and sell the stock at the higher price. If the stock goes up, the short seller simply allows his put to expire. Then his only loss is the cost of the put.

Either way, the fact that 20% of Borders stock is held by short sellers doesn't bode well for the company's quarterly results. That means one in five shareholders expects the stock to go down.

Stay tuned . . . and read on. This is a two-post day.

Maya (whose first job out of college was at a stock brokerage house)

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