CDS for stocks

July 19, 2011 2:05 PM

Is there something like a Credit Default Swap for stocks? Or, could I have gotten rich somehow by betting against Borders? Is there a way to bet that Groupon fails, for example?
posted by shotgunbooty to Work & Money (25 answers total)

You can sell stocks short.

You can buy puts on stocks.
posted by Perplexity at 2:08 PM on July 19, 2011 [1 favorite]

Are you talking about short selling stocks?
posted by brainmouse at 2:08 PM on July 19, 2011 [1 favorite]

You have a couple options:

Shorting the stock
Buying put options
Selling call options (only for the insane, as potential losses are more than you put in and unlimited).

There are also some inverse Exchange Traded Funds, but not in a single stock, that I know of. Also there are single stock futures, but I have never used them.
posted by procrastination at 2:09 PM on July 19, 2011 [1 favorite]

Oy. That you're asking this question in a forum like this suggests that you should not be trying to place these bets.

As others have mentioned, you can short stocks, but that is a very dicey practice, and it is hard, even for professionals, to consistently make money at it. And shorting stocks has nothing to do with credit default swaps.
posted by dfriedman at 2:14 PM on July 19, 2011 [9 favorites]

Brief summary of the concept behind shorting, so you don't need to read wikipedia.

When you short, you borrow stocks from someone, then immediately sell them. You're obliged at some later date to return those stocks. That's called 'covering'. If the price goes up, you lose money, if the price goes down, you make money when you cover.

You can lose a lot of money really quickly shorting a stock, though, so be careful. Most stocks go up, not down.
posted by empath at 2:16 PM on July 19, 2011

Everybody has known for years that Border's was dead man walking, so you wouldn't have made money anyways.
posted by goethean at 2:21 PM on July 19, 2011

In addition to what others have said, you can buy CDS on the debt of the publicly traded company.

Calculating mismatches in pricing between put options and CDS on the same company is one way that quant traders make money.
posted by michaelh at 2:27 PM on July 19, 2011

To follow up goethean, Borders hasn't traded above 2 since May of last year. The market has been essentially betting against it for quite a while.

As for shorting in general, the classic argument against it is this- when you buy stocks, your potential losses are finite (it drops to zero), but your potential gains are infinite (however high it rises). When you short, it's the opposite- your potential losses have no bounds.
posted by mkultra at 2:27 PM on July 19, 2011

Everybody has known for years that Border's was dead man walking, so you wouldn't have made money anyways.

FWIW, Border's last day of trading was February 15, 2011, filing for Chapter 11 the day after. Ticker BGP.

There are safer ways to bet against the market than a true short. There are ETFs and other funds that you can invest in that specifically short stocks and keep risks hedged.

IANA accountant, financial advisor, etc. TINFA.
posted by Mister Fabulous at 2:32 PM on July 19, 2011

You could invest in amazon.
posted by villanelles at dawn at 2:41 PM on July 19, 2011

If you want to bet against a stock, bet against LinkedIn, their P/E ratio is about 2800:1. That's about as lost risk as you can get with shorting. Of course there's a good chance you will lose a buttload of money too.
posted by blue_beetle at 2:42 PM on July 19, 2011 [1 favorite]

Yes as others have said your main options are shorting or buying puts. With shorting especially, you are taking on a huge amount of risk (for example, if you short a stock when it costs $5/share and it goes up to $50/share, you have to pay 10 times as much to cover your short than the original amount you borrowed).

Is there a way to bet that Groupon fails, for example?

Groupon is a private company right now, so you can't buy shares or really take any kind of financial position with regard to their success or failure. They have rejected several takeover bids and are apparently actually planning on going public, although that process will probably take years.

Most stocks go up, not down.

Right, that is really the main reason why taking a short position is a bad idea in general. Investing is not about predicting whether a particular stock goes up or down, it's more about the fact that in general, companies make money and through a complex system of market forces that results in the stock price increasing. The current price of any given stock represents what the combined brainpower of all investors using all of the information known about the company think the stock is worth. Usually by the time a normal person who does not have any kind of secret information about a company figures out that its stock is overpriced, the price has already dropped. You could have made a ton of money betting that Enron for example was going to fail, but that would have only made sense if you knew about Enron's accounting cheats and the fact that their profit numbers were all made up, which the normal employees of Enron didn't even know. With Borders you would have had to realize they were going to go bankrupt (which probably also would have meant predicting the overall financial crash that did them in) back when they were making money hand over fist and expanding rapidly. Basically if your investment strategy involves proving the market wrong about how well they think a given company will do, which a short position inherently does, it's a good sign that you should rethink your investment strategy.
posted by burnmp3s at 2:42 PM on July 19, 2011 [1 favorite]

However dumb and non-sustainable GroupOn's business model may be, there is still a chance that they will get bought. If they do that then they have succeeded and you are out a bunch of bucks.
posted by It's Never Lurgi at 2:48 PM on July 19, 2011 [1 favorite]

I have dabbled in shorting and it left me wary -- and quite a bit poorer. Even if you are certain a stock will go down, it may go up in the meantime, and one day your broker will call and say "you don't have enough money in your account to meet the legal requirements, so you need to sell now, or put more money in."
posted by smackfu at 3:10 PM on July 19, 2011

Don't short sell; buy put options. The most you can lose is the price you bought the options at, which is almost nothing.

Speculation isn't a good investment strategy, but if you treat it as entertainment, you'll be fine. Just remember to avoid making any trades where your downside is unlimited, because then the entertainment aspect evaporates quickly.
posted by jrockway at 3:38 PM on July 19, 2011 [1 favorite]

You could have made a ton of money betting that Enron for example was going to fail, but that would have only made sense if you knew about Enron's accounting cheats and the fact that their profit numbers were all made up, which the normal employees of Enron didn't even know.

And if you are the kind of person that knew this when it mattered, you'd probably go to prison for shorting the stock.
posted by empath at 3:42 PM on July 19, 2011

And if you are the kind of person that knew this when it mattered, you'd probably go to prison for shorting the stock.

I recall reading a project paper from an Cornell MBA class that looked at Enron before it was exposed and fell apart. The statistical measures of fraudulent accounting said they were engaging in a lot of risk for no return, and were probably cheating. Of course, they blindly assumed Enron knew what it was doing because they're a Fortune 100 company and not even an MBA education can bestow critical thinking. But it was an open secret for people who know how to read the SEC documents that these special purpose entities were problematic.

Anyways, as Mister Fabulous points out, Borders has been in pink sheets for some time. You would have had to short this a year or two ago, and you'd be shorting something everyone knew was a dog. Groupon isn't yet public, and the problem you have is timing; options expire and shorts cost you interest. You need to know not only that the market price will fall, but will do so in short order. After those students studied enron, it still took the world another two years to decide they were right. That's a hell of a long time live life as though the world is mad and you're the only sane one left.
posted by pwnguin at 4:28 PM on July 19, 2011 [2 favorites]

Not to derail this thread but Enron's accounting made it a target for short seller for years, none of whom had inside information, and many of whom lost money trying to short the stock.
posted by dfriedman at 4:48 PM on July 19, 2011

Yup the world is filled with people who got carried out on momentum shorts that they were actually right about. They tend to be really really bad investments until they are really really good investments. Also don't forget that unlike a long the position going against you can't be cost averaged down, and lots of crazy momentum stock will have very rich borrows that can eat up a non-trivial amount of your return. Not to mention your broker needs to find borrow.

There are lots on inefficiencies in shorting stocks. Even guys like Chanos don't make money in absolute terms over the long-term.
posted by JPD at 5:14 PM on July 19, 2011

Many people in the thread have mentioned short selling and options. I've got a few years of experience with both, so I'll mention that as a practical matter it can be hard to find someone to take the other side of the trade.

In the case of shorting, if the stock is heavily shorted, your broker may not be able to find any stock for you to borrow. Ironically, this activity (short selling) can drive the price up (a short squeeze). As trades go underwater for people and they decide to close their position by buying stock back to cover the short, they generate more demand which drives the price even higher. It can be a very painful experience if you are on the wrong side of one of these trades.

In the case of options, you have to remember that there are many different option chains: for a given stock, options have different strike prices and different expiration dates. So to buy a particular option, there has to be someone on the other side of the trade willing to "take that bet". Option pricing isn't nearly as efficient as stock pricing; because of the comparatively lower volumes, there is a lot more variance between bid and ask. An experience I have often had is either not being able to find a trade on a particular option chain at any price, or finding the trade but with an ask price very inflated from what I thought was fair value.

In a nutshell, timing is everything. It isn't enough to recognize that Border's is tanking, you need to recognize it early enough that you can find people who still think Border's is going to make it and will take the other side of your trades without a ridiculous risk premium. In the case of options, it is possible to be *too* early, as every option has an expiration date.

I eventually was able to make money off of these trading strategies, but I had a fairly painful year of what I now see as rookie mistakes. And it was a lot more work than a simple buy-and-hold stock strategy with comparable returns over the long haul between the two approaches. My main advice is that if you are going to incorporate short selling and options into your investment approach, there are a couple of pre-requisites: (a) be comfortable with trading individual stocks, like maybe you've executed a couple hundred trades already; (b) have money you can afford to lose while you learn (imagine you are learning poker); (c) [for options] have enough of a math background that you can at least intuitively grasp Black-Scholes theory and understand how options get priced; (d) [for options] read at least the first couple of chapters of McMillan's Options as a Strategic Investment.
posted by kovacs at 6:12 PM on July 19, 2011 [1 favorite]

If it is a publicly traded company and listed in any ETF or Index, to avoid the issues with finding a person to led you the stock to short, you could short the ETF and buy the individual stocks that comprise the ETF EXCEPT for the one you want to bet against or be short. If the correlation to the index is still over 90% then you would be subject to arbitrage margins which would make it a reasonable cost to enter the trade.

Groupon is not yet a public company, but without looking it up, I would bet they have public debt. If they do, you could do a CDS on those or short them.
posted by JohnnyGunn at 10:21 PM on July 19, 2011

FIrst off, I'm not a finance-type or a trader. I am interested in this sort of thing, though. Your question, boiled down, is "how do I make money on companies that fail?" Another way of saying this is "how do I make money by taking short positions?"

Above, the commentors have laid out the riskiness of doing this. kovacs went one step further by advising you on a text that details the specifics of options investing. I'd like to tack this bit on, so you get a sense of how one hedge fund that deals exclusively in options operates:

At Empirica, by contrast, every day brings a small but real possibility that they'll make a huge amount of money in a day; no chance that they'll blow up; and a very large possibility that they'll lose a small amount of money. All those dollar, and fifty-cent, and nickel options that Empirica has accumulated, few of which will ever be used, soon begin to add up. By looking at a particular column on the computer screens showing Empirica's positions, anyone at the firm can tell you precisely how much money Empirica has lost or made so far that day. At 11:30 A.M., for instance, they had recovered just twenty-eight percent of the money they had spent that day on options. By 12:30, they had recovered forty per cent, meaning that the day was not yet half over and Empirica was already in the red to the tune of several hundred thousand dollars. The day before that, it had made back eighty-five per cent of its money; the day before that, forty-eight per cent; the day before that, sixty-five per cent; and the day before that also sixty-five per cent; and, in fact-with a few notable exceptions, like the few days when the market reopened after September 11th -- Empirica has done nothing but lose money since last April. "We cannot blow up, we can only bleed to death," Taleb says, and bleeding to death, absorbing the pain of steady losses, is precisely what human beings are hardwired to avoid.

By the way, the emphasis above is mine. You, by no means, have to invest the way Empirica does, but my point is that there are many players with a whole lot of research ability, a great deal of mathematical skill, and an inhuman tolerance for loss playing this game.
posted by Hypnotic Chick at 7:50 AM on July 20, 2011

Don't do this. Even if you know the company is going to fail, you have to know when it will fail and how much the stockholders will eke out after bankruptcy. There are very smart people and algorithms that take all the easy money to be made this way.
posted by miyabo at 7:59 AM on July 20, 2011

bah...as long as you realize that you are GAMBLING and not investing, buying a block of puts isn't going to PUT (*wince*) you in the poorhouse or anything. Just remember that what you are doing isn't really that much different than buying lotto scratchers or shooting dice.

I have a VERY small portion of my portfolio devoted to "effing around" like this. My returns over the past 10 years have been volatile but net positive (not as positive as the rest of my investments but still positive). Most of the activity has been buying calls and puts...normally with strike dates 6 months or so out.

Nthing leaving shorting shares and selling calls to the pros.
posted by screamingnotlaughing at 2:43 PM on July 20, 2011

They [Groupon] have rejected several takeover bids and are apparently actually planning on going public, although that process will probably take years.

For the record, Groupon filed their S-1 in June. As a comparison, Linkedin and Pandora both filed their S-1s in February of this year and went public in May and June, respectively. On the other hand, Zipcar filed their S-1 in June 2010 but didn't go public until April 2011. Make of that what you will.
posted by mhum at 7:51 AM on July 21, 2011