filed in Simplified Sunday Series on Apr.11, 2009
This week, I decided I would answer a couple of emails that I got from readers on certain topics. These in my opinion are very good questions that should be shared with all of you. I will start using some of the Sunday sessions to answer these in the most simplistic manner.
What is the difference between options and futures?
Short answer, with futures, you are obligated to purchase ownership in a stock. With options, you have only reserved the right to purchase the stock, but don’t have to (if you changed your mind) at a specific price. Futures are contracts and like any other contract you can think of, there are rules both sides must adhere to and your end is to take ownership at a predetermined price.
Also, futures are normally larger in size and not truly good for the average investor. With options, you can get as little as 1 contract (equal to 100 shares).
What does “short squeeze” mean?
I talk about this at times when there are stocks that have been shorted heavily on the market and suddenly shoot up 20-50% for no reason. Traders takes advantage of a stock that has been short sold substantially by buying up large blocks of the stock. This causes the stock price to jump up dramatically and forces short sellers to buy the stock in order to close out their positions and cut their losses.
Because the trader has bought up large blocks of the stock, the short sellers may find it very difficult to buy stock at a price that they prefer. The trader can then sell the stock to the desperate short sellers at a higher premium. This can be see on jumps recently fro (C) which was around $0.99 and then shot up to $3 before falling back down. Also stocks like (LVS) also had this mechanism of action.
Some will say that a short squeeze is hard to do. Technically speaking, this is true. However, with the panic driven volatility, people are trying to make money shorting more and more which backfires for the amateur who gets trapped when big institutions purchase large blocks of these batter stocks at bargains. Personally, I wait for these short squeeze formations occur and try to save off a small gain from the big rally and then wait for the cycle to happen again.
Some stocks constantly just cycle in an up/down pattern. They get heavy short interest to a certain level, then a short squeeze occurs before the stock is shorted again.
Currently the SEC is considering new rules to discourage the practice of shorting stocks, soon enough we will see these and how how they play into the short squeeze.
Hope you all picked up something new this week. Until next Sunday…
- Simplified Sunday #18 – Short Selling Intro (Part 3)
- Simplified Sunday #17 – Short Selling Intro (Part 2)
- Simplified Sunday #20 – Question Bag – When to Trade? Why Bold Symbols?