Comment by GeZe | Hacker News Reader

Comment by GeZe | Hacker News Reader

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By shorting the stock.

http://en.wikipedia.org/wiki/Short_selling

Basically, the hedge funds thought the stock would go down, so they "borrowed" or "rented" the stock from someone else and immediately sold it. The idea is by the time they have to return the stock the price will have fell.

Ie, if the stock is currently worth $100, and they borrow 1 share and immediately sell it, they have $100 and owe 1 share. Later, on the date they have to return 1 share, they go and buy 1 share and give it back. If the share price then is $80 they made $20 on the transaction. If the stock went up to $120 then they lost $20.

So, they shorted the stock, because they thought it would go down, but then the amount of stock available to be bought plunged right as they had to return the stock. So, there was a huge demand for the stock right as the supply was drying up. As such, the price went very high, but they were forced to buy it anyways to due to the previous agreement (that they had to give the stock back).

Thanks for that.

The only other question is why hedges decided to short VW's stock. But the article kind of explains that: Porsche's previous buying up for VW stock pushed VW's stock too high for VW's profitability.

It startles me, if it's true, that 1) Porsche knew they had pushed VW's stock too high, 2) Porsche knew the hedges would know this, and try to short them, and 3) the hedges would lose huge amounts when it transpires that Porsche actually had most of VW's stock anyway, leaving only a small fraction of available stock, which all the hedges would scramble to buy back, hence fill Porsche's pockets, to fulfill their short contracts.

I guess i'd only be illegal if the German courts can prove Porsche misled (manipulated) the market into believing their was more stock available than there actually was.

Isn't that what hedge fund do themselves everyday ?

That always sounds strange to me... why would you lend you stock so somebody else can make money out of it?

You have to pay to borrow. If you're a small shareholder, your shares are available for your broker to lend if you borrow money against them; a large institution is usually able to negotiate rates at which it will lend its shares.

Humm... as a sort of hedging against the stock going down?

It's not really a hedge. A hedge would be something with an inverse correlation -- so when the stock went down, your borrowing income would go up. In general, the opposite is the case: if the stock goes down, but the borrowing cost is the same in percentage terms, your borrowing income goes down. The exception is if the stock goes down and demand for shorting goes up so fast that the interest rate on borrowed stock goes up. Even then, it will almost certainly be a small cushion (losing 49% instead of 50%) not a hedge.

That said, it's still income you wouldn't otherwise have.

Better question is why you would sell short stock in a company that someone is known to want to buy?

It's always like that - someone sells, someone buys. It's always exactly 50/50.

>why would you lend you stock so somebody else can make money out of it?

You think it's going up, so you keep it. They think it's going down, so they borrow it from you and sell it.

They'll return it eventually, so you don't care - you don't need it right now.

thanks GeZe. That made a lot of sense. I am usually extremely confused while reading financial news, I can't make sense of the jargon.

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