Legal Definitions - sale short

A sale short refers to the practice of selling an asset, such as shares of stock or a commodity, that the seller does not currently own. In this transaction, the seller first borrows the asset from a third party (often a brokerage firm) and then immediately sells it on the open market. The underlying expectation of the seller is that the price of the asset will decrease in the future.

If the price does fall as anticipated, the seller then buys back the same asset at the lower market price and returns it to the original lender. The profit generated from a sale short is the difference between the higher price at which the asset was initially sold and the lower price at which it was repurchased, minus any borrowing fees or commissions. This strategy is typically employed by investors who believe an asset is overvalued and its price is likely to decline.

• Example 1: Stock Market Investment

  An investor named Michael believes that the shares of "Tech Innovations Inc." are significantly overvalued and expects their price to drop after the company announces its next quarterly earnings. To capitalize on this anticipated decline, Michael borrows 200 shares of Tech Innovations Inc. stock from his brokerage firm and immediately sells them on the stock exchange for $75 per share, receiving $15,000. This initial transaction constitutes a sale short.

  A month later, after a disappointing earnings report, the stock price of Tech Innovations Inc. falls to $60 per share. Michael then buys 200 shares back for $12,000 and returns them to his brokerage. Michael successfully executed a sale short, profiting $3,000 (before fees) from the difference between his selling price and his repurchase price.

• Example 2: Commodity Futures Trading

  A commodities trader, Sarah, analyzes global agricultural reports and forecasts that a bumper harvest of corn will lead to a significant surplus, causing corn prices to fall in the coming months. To profit from this prediction, Sarah enters into a futures contract to sell 5,000 bushels of corn at a price of $4.50 per bushel, even though she does not currently own the corn. This commitment to sell a commodity she doesn't possess is a form of sale short.

  As predicted, when the harvest comes in, corn prices drop to $4.00 per bushel. Sarah then buys an equivalent futures contract at the lower price to cover her obligation. By engaging in a sale short, Sarah's trading firm profited from the $0.50 per bushel difference, totaling $2,500 (before transaction costs).