Short Lots

Short lots work pretty much the same as long lots, but with buys and sells reversed. In short lots, a position is opened by selling shares you do not technically own yet (which makes you money), and closed by buying shares at a later date to cover the transaction (which costs you money). This way, you make money if the security's price goes down, and lose money if it goes up.

The most important difference with short lots is the definition of cost basis. Since the gains from a short sale transaction are not realized until a covering buy is made, Google Finance computes the value of an uncovered short as if a covering buy were made at the current stock price. For this reason, both the basis and the return are dependent upon the price of the stock.

Short Lot Computations

  • Initial investment: This is the same as for long lots: it is the negative of the cash value of the transaction that opens the lot. However, because that translation is a sale, the cash value is positive, and the initial investment is negative.
  • Purchase cost: This is equivalent to the cost basis of a long lot. purchase cost = initial investment * (remaining quantity / initial quantity) But remember that because the initial investment is negative, so is the purchase cost.
  • Cost basis: cost basis = remaining quantity * share price
  • Market value: market value = -(remaining quantity) * share price = -cost basis
  • Gain: Recall that for a long lot, gain is the difference between how much you would make by selling your current holdings of an asset at the current market price, and how much you originally paid for that asset. Short sales can be a little counterintuitive, because your income is realized at the time you open the position, and the cost is paid at the time of buying the shares to cover that sale. The gain is still the difference between your income and outlay. When you make a short sale, you incur an obligation to later purchase shares to cover the sale. Therefore, the amount of the outlay is dependent on the current market price and your number of currently held shares. Your income, on the other hand, is fixed based on the price of the stock at the time you made the short sale -- this is your "cash in". Gain = cash in + market value. (Remember that market value is negative)
  • Today's gain: today's gain = -(remaining quantity) * price change
  • Gain percentage: gain percentage = gain / cost basis
  • Returns gain: If your lot includes any covered buy transactions, these are also treated as outlays, but instead of being based on the current market price, they are computed with the price associated with the buy transaction -- this is your "cash out". Returns gain = cash in - (-market value + cash out).
  • Overall return: As with long lots, this is your returns gain as a percentage of your overall outlay on all shares in the lot, not solely those you still hold. Overall return = cash in - (-market value + cash out) / (-market value + cash out)

 

Since short lots can be counterintuitive, an example is in order:

Transaction: 4/1/2008 SHORT SELL XYZZ 100 @ $471.09 ($15 commission)

At this point you have an obligation to deliver 100 shares at some point in the future. Suppose the stock is now trading at $450, down $10 since the market open.

 

Then:

  • Initial investment = -$47,094
  • Purchase cost = -$47,094 -> This is a negative cost, because you made money on this part of the deal.
  • Cost basis is 100 * $450 = $45,000.
  • Market value is -100 * $450 = -$45,000 -> Since this is an obligation to provide a security, not a security you own, the value is negative.
  • Gain is $47,094 + (-$45,000) = $2,094 -> Since the stock went down since purchase, you would make money if you bought shares today to cover the sale.
  • Today's gain is -100 * (-$10) = $1,000 -> Since the stock went down today, the amount of money you stand to make went up.
  • Gain percentage is $2,094 / $45,000 = 4.65% -> This is the percentage you would make if you bought shares today to cover the sale, since you spend $45,000 to make a $2,094 profit.
  • Cash in = $47,094
  • Returns gain = $47,094 - (-(-$45,000)) = $2,094 -> Short lots mean lots of negative numbers!
  • Overall return = $2,094 / $45,000 = 4.65%

It gets a little trickier if your short lot includes some covered buys. Consider this example:

Transaction 1: 4/1/2008 SHORT SELL XYZZ 100 @ $471.09 ($15 commission)

Transaction 2: 5/5/2008 BUY TO COVER XYZZ 50 @ $573.20 ($15 commission)

We calculate the same numbers, bearing in mind that you only hold obligations to sell 50 shares at the time of calculation. Suppose the stock is now trading at $450, down $10 since the market open.

Then:

  • Initial investment = -$47,094
  • Purchase cost = -$47,094 * (50 / 100) = -$23,547
  • Cost basis is 50 * $450 = $22,500
  • Market value is -50 * $450 = -$22,500
  • Gain is $23,547 + (-$22,500) = $1,047
  • Today's gain is -50 * (-$10) = $500
  • Gain percentage is $1,047 / $22,500 = 4.65%
  • Cash in (transaction 1) is $47,094
  • Cash out (transaction 2) is $28,675
  • Returns gain = $47,094 - (-(-$22,500) + $28,675) = -$4,081
  • Overall return = -$4,081 / (-(-$22,500) + $28,675) = -7.97%

Transaction: 5/5/2008 BUY TO COVER XYZZ 50 @ $573.20 ($15 commission) -> Now you own 50 shares. The cost basis is 50 * 471.09 + 7.50 = $23,562. (Remember that commission costs are apportioned across all the shares you bought originally.)