Short Selling - A Profitable Example
Note: To simplify the explanation, no commissions or lending fees are used in the calculations below.
ABC company is currently selling for $50 per share. A team believes this is overpriced and due to fall in value.
On turn 12, they short sell 1,000 shares. The proceeds from the sale are $50,000.
Because an increase in price would mean additional money would be needed to cover the position, a 50% margin ($25,000) is taken from their on-hand cash, putting $75,000 on account.
On turn 17, ABC has fallen to $40. The team must now cover that position, purchasing the 1,000 shares at $40. The $40,000 is taken from the proceeds of the sale ($50,000) leaving $10,000. They also receive their $25,000 margin returned in full, as it was not needed for covering the position, since the stock fell in value.
Therefore they receive $35,000 back in the on-hand cash.