Short Selling : Strategies, Risks, and Rewards

435 Pages·2006·5.08 MB·English

by  Frank J. Fabozzi

ffirs.frm Page iii Thursday, August 5, 2004 10:42 AM
Short
Selling
Strategies, Risks, and Rewards
FRANK J. FABOZZI
EDITOR
John Wiley & Sons, Inc.
Sect1 Page 8 Thursday, August 5, 2004 10:45 AM
ffirs.frm Page i Thursday, August 5, 2004 10:42 AM
Short
Selling
ffirs.frm Page ii Thursday, August 5, 2004 10:42 AM
THE FRANK J. FABOZZI SERIES
Fixed Income Securities, Second Edition by Frank J. Fabozzi
Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L.
Grant and James A. Abate
Handbook of Global Fixed Income Calculations by Dragomir Krgin
Managing a Corporate Bond Portfolio by Leland E. Crabbe and Frank J. Fabozzi
Real Options and Option-Embedded Securities by William T. Moore
Capital Budgeting: Theory and Practice by Pamela P. Peterson and Frank J. Fabozzi
The Exchange-Traded Funds Manual by Gary L. Gastineau
Professional Perspectives on Fixed Income Portfolio Management, Volume 3 edited
by Frank J. Fabozzi
Investing in Emerging Fixed Income Markets edited by Frank J. Fabozzi and
Efstathia Pilarinu
Handbook of Alternative Assets by Mark J. P. Anson
The Exchange-Traded Funds Manual by Gary L. Gastineau
The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, and
Moorad Choudhry
The Handbook of Financial Instruments edited by Frank J. Fabozzi
Collateralized Debt Obligations: Structures and Analysis by Laurie S. Goodman
and Frank J. Fabozzi
Interest Rate, Term Structure, and Valuation Modeling edited by Frank J. Fabozzi
Investment Performance Measurement by Bruce J. Feibel
The Handbook of Equity Style Management edited by T. Daniel Coggin and
Frank J. Fabozzi
The Theory and Practice of Investment Management edited by Frank J. Fabozzi and
Harry M. Markowitz
Foundations of Economic Value Added: Second Edition by James L. Grant
Financial Management and Analysis: Second Edition by Frank J. Fabozzi and
Pamela P. Peterson
Measuring and Controlling Interest Rate and Credit Risk: Second Edition by
Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry
Professional Perspectives on Fixed Income Portfolio Management, Volume 4 edited
by Frank J. Fabozzi
The Handbook of European Fixed Income Securities edited by Frank J. Fabozzi
and Moorad Choudhry
The Handbook of European Structured Financial Products edited by Frank J.
Fabozzi and Moorad Choudhry
The Mathematics of Financial Modeling and Investment Management by Sergio M.
Focardi and Frank J. Fabozzi
ffirs.frm Page iii Thursday, August 5, 2004 10:42 AM
Short
Selling
Strategies, Risks, and Rewards
FRANK J. FABOZZI
EDITOR
John Wiley & Sons, Inc.
ffirs.frm Page iv Thursday, August 5, 2004 10:42 AM
Copyright © 2004 by John Wiley & Sons, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in
any form or by any means, electronic, mechanical, photocopying, recording, scanning, or oth-
erwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright
Act, without either the prior written permission of the Publisher, or authorization through
payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rose-
wood Drive, Danvers, MA 01923, 978-750-8400, fax [phone], or on the web at
www.copyright.com. Requests to the Publisher for permission should be addressed to the Per-
missions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-
748-6011, fax [phone].
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best
efforts in preparing this book, they make no representations or warranties with respect to the
accuracy or completeness of the contents of this book and specifically disclaim any implied
warranties of merchantability or fitness for a particular purpose. No warranty may be created
or extended by sales representatives or written sales materials. The advice and strategies con-
tained herein may not be suitable for your situation. You should consult with a professional
where appropriate. Neither the publisher nor author shall be liable for any loss of profit or
any other commercial damages, including but not limited to special, incidental, consequential,
or other damages.
For general information on our other products and services, or technical support, please con-
tact our Customer Care Department within the United States at 800-762-2974, outside the
United States at 317-572-3993, or fax [phone].
Wiley also publishes its books in a variety of electronic formats. Some content that appears in
print may not be available in electronic books.
For more information about Wiley, visit our web site at www.wiley.com.
ISBN: 0-471-66020-5
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
ftoc.frm Page v Thursday, August 5, 2004 10:40 AM
Contents
Foreword ix
Clifford S. Asness
Preface xiv
About the Editor xv
Contributing Authors xvi
CHAPTER 1
Introduction 1
Frank J. Fabozzi, Steven L. Jones, and Glen Larsen
SECTION ONE
The Mechanics of Short Selling 7
CHAPTER 2
Mechanics of the Equity Lending Market 9
Jeff Cohen, David Haushalter, and Adam V. Reed
The Lending Process 10
Lenders 11
Borrowers 13
The Determinants of Rebate Rates 15
Conclusion 16
CHAPTER 3
Shorting Using Futures and Options 17
Frank J. Fabozzi
Futures Contracts 17
Equity Options 30
Summary 36
v
ftoc.frm Page vi Thursday, August 5, 2004 10:40 AM
vi
Contents
CHAPTER 4
Is Selling ETFs Short a Financial “Extreme Sport”? 37
Gary L. Gastineau
What Are the Most Important Safety Features
Protecting ETF Short Sellers? 38
How Do ETFs Work in Risk Management Applications? 39
Who Owns ETF Shares? 43
Will It Always Be Possible to Borrow ETF Shares at
Low-Cost for Risk Management Applications? 47
What Is the Effect of Short Selling and Risk Management
Activity on ETF Trading Volume and Trading Costs? 49
Are Risk Management Applications and Heavy ETF Share Trading
Desirable for Fund Shareholders and Fund Advisors? 51
What Is the Significance of the Short Interest for
Growth in ETF Assets? 52
Conclusion 56
SECTION TWO
Theory and Evidence on Short Selling 59
CHAPTER 5
Restrictions on Short Selling and Exploitable Opportunities for Investors 61
Edward M. Miller
Demand and Supply Curves Arguments 62
The Pattern of Stock Prices Over Time with
Uninformed Investors 75
The Bounded Efficient Markets Hypothesis 91
Conclusions 114
CHAPTER 6
Implications of Short Selling and Divergence of Opinion for Investment Strategy 117
Edward M. Miller
Interaction of Divergence of Opinion and Short Selling Restrictions 119
Empirical Tests 134
Conclusions 176
CHAPTER 7
Short Sale Constraints and Overpricing 179
Owen A. Lamont
Short Sale Constraints 180
The Overpricing Hypothesis 184
Costs of Shorting 188
Go Down Fighting 191
3Com/Palm 193
Tech Stock Mania and Short Sale Constraints 200
Summary 203
ftoc.frm Page vii Thursday, August 5, 2004 10:40 AM
vii
Contents
CHAPTER 8
How Short Selling Expands the Investment Opportunity Set and
Improves Upon Potential Portfolio Efficiency 205
Steven L. Jones and Glen Larsen
Short Selling in Efficient Portfolios: The Theory and
Its Practical Implications 207
The Empirical Evidence on Short Positions in Ex Post
Efficient Portfolios 229
Concluding Remarks and Practical Implications for Investors 231
CHAPTER 9
The Information Content of Short Sales 233
Steven L. Jones and Glen Larsen
Short Sales: Reporting, Frequency, and Constraints 235
Academic Theory versus the Technical Analyst’s View 236
The Empirical Evidence 239
Conclusions and Implications for Investors 253
SECTION THREE
Short Selling Strategies 257
CHAPTER 10
Spotting Clues in Qs 259
Ron Gutfleish and Lee Atzil
Looking for the Easier Fight 260
Putting on the Green Eyeshades 261
So What? It’s Only Accounting 265
How Do You Find these Cases? 266
Diagnosis 270
Keeping Your Shorts On 270
Tales from the Front Lines: Three Examples 271
Summary 278
CHAPTER 11
The Economic Profit Approach to Short Selling 279
James A. Abate and James L. Grant
Short Selling in the Theory of Finance 280
Tenets of Good and Bad Companies 280
Positive NPV: Discovery of Good Companies 281
Negative NPV: Discovery of Bad Companies 284
Zero NPV: Wealth Neutral Companies 287
Case Studies 287
Role of the Value/Capital Ratio 291
Invested Capital Growth 292
Managerial and Investor Implications 294