We are back at school and now we are going to learn about shorting stock.
When you want to make a bet on a company you buy the company's shares. But how about when you want to make a bet against a company? Just flip the equation: sell the firm's shares.
Yeah, I know, where are you going to come up with the shares when the clown who bought them demands that you fork over the stock? Brokers, you will be glad to know, have thought of every contingency. They will loan you the shares to sell! That way you can send the borrowed shares to the new buyer and never have to own it yourself. That's called short-selling.
Okay, so let's say you hear that National Gift Wrap might be having a tough quarter. Maybe you hear that the Xmas Mylar line isn't selling well. How do you profit off of it? You can sell National Gift Wrap short (as this is my Dad's company and he's having a pretty good fall, this would be a foolish bet if the company were actually public), say at $30 a share where it is currently selling, and bet that it falls to, say $25 when the bad news comes out.
You then pick up the five points difference. Had you done it a thousand times you would have made $5,000 betting against National Gift, quite a handsome return for your negativity.
Of course there are a set of rules that must be followed that are particular to short-selling. You need what is known as an "uptick," meaning someone has to pay a higher price for the shares than the last sale. So if National Gift Wrap is at $30, you can't just bang the shares out short, you have to wait until someone pays higher than the last sale to get the trade done.
I know, that seems unfair. But in the bad old pre-
days bears used to maul stocks by conducting bear raids, literally wrecking stocks by getting short and then knocking them down by selling shares they did not own. The government took that edge from shortsellers by making them wait until someone is willing to pay up.
The practical affects of this rule is that when you know it is going to be really ugly in the market, you can't just come in and get short. On big down days nobody is paying up from the last sale for anything, except stuff that you will lose your shirt on if you short anyway.
That's why many people buy puts, instead of going short, because the impracticality of shorting on really ugly days cannot be stressed enough.
One other arcane rule: you have to be able to borrow the shares to begin with. Some stocks are unavailable for borrowing, either because too many have borrowed them already or because the shares are held in a few hands none of whom keep their shares with brokers.
You don't want to short those stocks anyway, because they can rocket higher if someone buys them aggressively, triggering what is known as a short squeeze, the most dangerous aspect of short trading. Want to know the pain of a short squeeze? Check out my story on
(Ed's note: The Cramer school series, a continuing educational series, is kicking into full form for the holiday season. In the coming days and weeks Cramer the Teacher will provide lessons on puts, buying puts or calls and selling puts or calls.)
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Mr. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he welcomes your feedback, emailed to