What is a short sale?
The act of selling a borrowed security that the investor does not own in the hopes of buying it back later at a lower price.
Consider the following short-selling scenario:
Let's say you believe ABC Corporation, now selling at $50 per share, is going to plunge to $10. Here's what you could do:
First, you borrow 100 shares of ABC and sell it for $50 per share. That puts $5,000 in your account.
Then, let's say ABC falls to $10 per share just as you expected. You buy back the 100 shares at $10 per share and return them to the original owner. But all it costs you is $1,000. You still have $4,000 in your account, a very hefty profit.
The goal is the same as buying low and selling high -- but in reverse. First, you sell high ... then you buy low.
But if ABC goes up, you lose. However, you can help control that risk by setting a stop-loss. In this case, for example, you could tell your broker to close out the transaction if ABC rises to $60 or more, helping to limit your loss to $1,000.
What are LEAPS?
The acronym stands for Long-Term Equity AnticiPation Securities. LEAPS are just options with terms from 1 to 3 years.
Are all option contracts based on 100 shares?
All options that trade on listed exchanges in the U.S. are based on 100 shares of stock. Occasionally, there are some exceptions, chiefly when two companies with listed options merge. When this happens and you own an option on one of the companies' shares, it's best to check with your broker to see if there are any changes in the option.
Where can I find more information about options and LEAPS?
To find out more information about options and LEAPS, visit our Guide to Options & LEAPS in the Investing Basics section of this website.
What is the difference between a Treasury Bill, a Treasury Note, and a Treasury Bond?
T-bills are short-term government debt instruments with maturities of 3, 6, or 12 months. T-notes are longer-term government debt instruments with maturities from one to 10 years. T-bonds are government debt instruments with maturities over 10 years.
What does "cover" mean in relation to a short sale?
To eliminate a short position by buying the underlying securities.
What does "or better" mean when you give instructions to buy or sell a stock?
When buying, it means purchasing the investment at the stated price or lower, if possible. When selling, it means at the stated sale price or higher.
What is the difference between debt and equity financing?
Companies must raise money to finance their on going operations. The two basic methods are debt and equity. With debt, money is borrowed under an agreement to repay over a period of time at a specific interest rate. Equity financing is the selling of an ownership stake in the company.
What is leverage?
In investments, this is the control of a large amount of money by a smaller amount of money. In finance, this is the relationship of debt to equity on a company's balance sheet. The higher the debt in relation to equity, the more leverage exists.
What is a derivative security?
A financial instrument whose value is based on, and determined by, another security or benchmark. This includes: Options, futures, interest rate swaps, and floating-rate notes.
What are futures contracts?
A commodity exchange agreement to sell or buy a specific amount of a commodity or security at a specific price and time.
What does a "protective stop" mean?
A protective stop is used to help mitigate the risk of loss in a particular investment. For example, when you own a security, you could place an order with your broker to sell if the security falls below a certain point. In other words, you would use a protective stop to sell out the security when its price falls to a point where the expected uptrend is no longer valid.
In a short sale, a protective stop is an order to purchase the security when its price rises to a point where the expected downtrend is no longer valid.
Note: Placing a protective stop does not guarantee that your order will be filled at the "stop price." Depending on market conditions, the price your stop order is filled at may vary, either better or worse for you. Still, a protective stop can go a long way in helping you reduce overall risk.
Can you recommend a broker?
An affiliate of Weiss Research -- Weiss Ratings, Inc. (www.weissratings.com) -- rates the safety of financial institutions, including brokerage firms. Therefore, to avoid conflicts of interest, it is our policy not to recommend specific brokers. However, our Broker Guide may help you to decide what type of broker will serve you best.
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