If you own 10K shares of stock XXX and you want to hedge your investment, isn't shorting some of your XXX identical to simply selling some of your XXX? Doesn't either approach reduce your risk in the same way . . . especially if you hope to buy back your sold shares at a lower price.
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In this case, selling is better than shorting, as you don't have to worry about margin calls, dividends etc. But to hedge your long position, you should probably sell some protective puts rather than selling your stock outright or shorting.– Victor123Commented Apr 27, 2014 at 18:47
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1You can't actually short until you first sell your existing shares.– VictorCommented Apr 28, 2014 at 8:16
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4 Answers
The point of short-selling as a separate instrument is that you can you do it when you can't sell the underlying asset... usually because you don't actually own any of it and in fact believe that it will go down. Shorting allows you to profit from a falling price.
Another (non-speculative) possibility is that you don't have the underlying asset right now (and thus can't sell it) but will get it at a certain point in the future, e.g. because it's bonds that you've used to guarantee a loan... or grain that's still growing on your fields.
answered Apr 26, 2014 at 19:41
If you already own shares in a company and sell some, you won't be short selling these shares if sold from the same brokerage account, because your existing shares with that broker need to be sold first before you are able to short sell any.
If you own a portfolio of shares however, you may be able to short sell an index to hedge your current portfolio.
Also, if you have your existing shares in a company but don't want to sell your existing shares, for example you don't want to crystallise a capital gain, you can always hedge you current shares by short selling them through a different broker.
Some other hedging options possibly available to you include: buying put options over the shares, writing cover call options, or short selling some other derivatives like CFDs (if your country allows them).
The word 'hedge' emerges from early agriculture when farmers would ask the market for a minimum buy price for each crop they planted. They used this method to stop loss against any major losses.
Investors today use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).
It's not quite identical, due to fees, stock rights, and reporting & tax obligations. But the primary difference is that a person could have voting rights in a company while maintaining zero economic exposure to the company, sometimes known as empty voting.
As an abstract matter, it's identical in that you reduce your financial exposure whether you sell your stock or short it. So the essence of your question is fundamentally true. But the details make it different. Of course there are fee differences in how your broker will handle it, and also margin requirements for shorting. Somebody playing games with overlapping features of ownership, sales, and purchases, may have tax and reporting obligations for straddles, wash sales, and related issues. A straight sale is generally less complicated for tax reporting purposes, and a loss is more likely to be respected than someone playing games with sales and purchases.
But the empty voting issue is an important difference. You could buy stock with rights such as voting, engage in other behavior such as forwards, shorts, or options to negate your economic exposure to the stock, while maintaining the right to vote. Of course in some cases this may have to be disclosed or may be covered by contract, and most people engaging in stock trades are unlikely to have meaningful voting power in a public company. But the principle is still there.
As explained in the article by Henry Hu and Bernie Black:
Hedge funds have been especially creative in decoupling voting rights from economic ownership. Sometimes they hold more votes than economic ownership - a pattern we call empty voting. In an extreme situation, a vote holder can have a negative economic interest and, thus, an incentive to vote in ways that reduce the company's share price. Sometimes investors hold more economic ownership than votes, though often with morphable voting rights - the de facto ability to acquire the votes if needed. We call this situation hidden (morphable) ownership because the economic ownership and (de facto) voting ownership are often not disclosed.
