To the Last Drop

Wall Street's bulls like to joke that "no Fifth Avenue mansions have been built by bears." The bulls are wrong. Though most investment profits have indeed been made on upswing, Bernard Baruch bagged one of his first fortunes by bearishly selling short in Amalgamated Copper in 1901, and Joseph P. Kennedy earned more than $1,000,000 by short-selling in 1929-30. Among the other famous bears who got into the honey in the Depression were Tom Bragg and "Sell 'em Ben" Smith. One day Smith picked up a phone to make a call, but Bragg bellowed: "Wait a minute--I'm short of Telephone. Don't give them any business now." Smith shot back: "Aw, I'm shorting Telephone myself, Tom. After I get done with this thing, I pick it up and drag it after me, wire and all. See?" Then Sell 'em Ben yanked the phone off the wall.

A lot of the fun and fortune has gone out of short selling--largely because of the Government's stern bans against the bear raids of old--but it is still an important, confusing and controversial factor in the stock market. Last week the New York Stock Exchange reported that short interest in the month ended Sept. 15 jumped by 708,000 shares, to an alltime high of 12,091,000 shares. Though that represented only 0.1% of all shares on the Big Board, it was the eleventh rise in the past 13 months and put the short interest 50% higher than a year ago. The increase raised all sorts of questions about the nature of short interest, and whether it suggests future strength or sag in the market.

How It Is Done. Short selling is the practice of selling borrowed stock in the expectation that the price will go down. The seller works through a regular stockbroker, who usually gets the shares by borrowing them from the margin accounts of other customers of his firm. If the stock drops, the seller can make a profit by "covering"--that is, buying depressed shares to pay off the loan of his borrowed shares. If the stock rises, he takes a loss when he covers. There is usually no time limit on the loan, and the short seller in theory can hold out indefinitely, waiting for the stock to drop.

There are a number of important factors that tend to hold down the amount of short selling. One is that the short seller has to deposit with the broker at least 70% of the cash value of the stock at the time of the deal, thus tying up his capital. Also, the seller has to pay to the lender any dividends issued on the stock during the period of the loan. If the stock value jumps, the broker can demand more cash, thus forcing the seller to rush for cover. Most important, any profits made on a short sale are taxed as straight income, not at the lower capital-gains rate.

Bullish or Bearish? When Wall Street is caught with its shorts up, it is evident that bears have been at work. On the other side, a large short interest technically promises an eventual upward pressure on the market when the short buy to cover. In an exercise called "squeezing the shorts," artful traders sometimes purchase big blocks of stock that have heavy short positions; the idea is to push the short sellers into buying to cover and driving up the price.

However, an increasing number of short sellers do not have to buy to cover because they already own the shares. About one-third of all short selling is merely "selling against the box," a device to delay tax payments. Instead of cashing in the stock that they wish to dispose of, sophisticated traders often go short in it and cover by delivering their own stock on Ian. 2, thereby putting Off tax payments on their profits for twelve months. "Selling against the box" usually causes the short interest to rise late in the year and fall in January. Short interest also tends to rise when many major mergers are under negotiation; some traders go both long and short on stocks in companies involved in merger talks to profit from differences between the market prices of the shares and what they stand to be worth after the merger. Also, a rising number of investment funds go short on some stock just to hedge their other investments.

At any rate, short selling is no game for novices or the fainthearted. The most that a buyer of stock stands to lose, even if his shares crash to zero, is his original investment. But the short seller's risk is unlimited, since technically there is no ceiling on how high a stock can rise.

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