Proper formula to calculate gain on a short trade?

[Lyehopper]

IIC (Doug) posed a question (on my thread) to Rob about calculating a gain on a short trade (and about the proper way to annualize a short term gain). The "annualize" question we'll pick up on later but.... Let's think about this how to properly calculate the % gain on a short (sold short) trade question....

I looked at my portfolio tracker on Vector-Vest and they track the gain just like we've always done it here on the POTW. When the shares are borrowed (or sold short) the cost basis is the current price at that time. My question to all the thinking people here is this.... Is that the cost basis of a short trade?.... or is the true cost basis the price when you cover or buy the shares to repay them to the brokerage?

Ask your self.... Does your brokerage care about how much $ the share price was at the time you borowed the share(s)?.... or do they just want the shares repaid at some time in the future reguardless of the cost to buy and cover the transaction. I think to reason properly on this we need to examine a winning and a losing short trade. In the following examples the trader in question (Quasi Ernie) had $100 in his margin account, not a penny more or less.

Example Trade #1:

Short Sell 1 share of XYZ @ $100
Buy to cover 1 share of XYZ @ $80

Now did he make 20% on this trade?.... or did he make 25%?

Example Trade #2:

Short Sell 1 share of ABC @ $100
Buy to cover 1 share ABC @ $120

Now did he lose 20% on this trade.... or did he lose 16.67%

This should be a fun discussion....

[IIC]

IIC (Doug) posed a question (on my thread) to Rob about calculating a gain on a short trade (and about the proper way to annualize a short term gain). The "annualize" question we'll pick up on later but.... Let's think about this how to properly calculate the % gain on a short (sold short) trade question....

I looked at my portfolio tracker on Vector-Vest and they track the gain just like we've always done it here on the POTW. When the shares are borrowed (or sold short) the cost basis is the current price at that time. My question to all the thinking people here is this.... Is that the cost basis of a short trade?.... or is the true cost basis the price when you cover or buy the shares to repay them to the brokerage?

Ask your self.... Does your brokerage care about how much $ the share price was at the time you borowed the share(s)?.... or do they just want the shares repaid at some time in the future reguardless of the cost to buy and cover the transaction. I think to reason properly on this we need to examine a winning and a losing short trade. In the following examples the trader in question (Quasi Ernie) had $100 in his margin account, not a penny more or less.

Example Trade #1:

Short Sell 1 share of XYZ @ $100
Buy to cover 1 share of XYZ @ $80

Now did he make 20% on this trade?.... or did he make 25%?

Example Trade #2:

Short Sell 1 share of ABC @ $100
Buy to cover 1 share ABC @ $120

Now did he lose 20% on this trade.... or did he lose 16.67%

This should be a fun discussion....

Well...I already conceded that to Rob on your thread...But now to the next discussion...Annualized Pecentage Gains/Losses.

[skiracer]

IIC (Doug) posed a question (on my thread) to Rob about calculating a gain on a short trade (and about the proper way to annualize a short term gain). The "annualize" question we'll pick up on later but.... Let's think about this how to properly calculate the % gain on a short (sold short) trade question....

I looked at my portfolio tracker on Vector-Vest and they track the gain just like we've always done it here on the POTW. When the shares are borrowed (or sold short) the cost basis is the current price at that time. My question to all the thinking people here is this.... Is that the cost basis of a short trade?.... or is the true cost basis the price when you cover or buy the shares to repay them to the brokerage?

Ask your self.... Does your brokerage care about how much $ the share price was at the time you borowed the share(s)?.... or do they just want the shares repaid at some time in the future reguardless of the cost to buy and cover the transaction. I think to reason properly on this we need to examine a winning and a losing short trade. In the following examples the trader in question (Quasi Ernie) had $100 in his margin account, not a penny more or less.

Example Trade #1:

Short Sell 1 share of XYZ @ $100
Buy to cover 1 share of XYZ @ $80

Now did he make 20% on this trade?.... or did he make 25%?

Example Trade #2:

Short Sell 1 share of ABC @ $100
Buy to cover 1 share ABC @ $120

Now did he lose 20% on this trade.... or did he lose 16.67%

This should be a fun discussion....

You can tell yourself anything you want but when you start with $100 and you end up with $120 you have $20 more. $20 / $100 + 20% gain regardless of long or short in my opinion. Less the commissions on both ends of course which will change the percentages and should be counted as part of the expenses of doing business.

[billyjoe]

Lye,
Funny you should mention $100. I was low on cash and asked my broker to lend me $100. He said,"sure", but he only had $50 so he would give me the rest later when his wife showed up . He gave me the $50 . I took it and said "forget about the other $50, lets just call it even" he agreed, smart fellow that he was. What is my gain on this deal ? a.) we're even b.) 50% c.) 100% or
d.) infinite

biilyjoe

[Lyehopper]

Well...I already conceded that to Rob on your thread...But now to the next discussion...Annualized Pecentage Gains/Losses.

Please know that I am not taking sides here. The annualizing question should be taken up elsewhere, I want to keep this thread focused.

Now I (for one) am not so sure Rob's right about calculating the short % gain the way he did for my spreadsheet program. I'd love to see some other opinions and discussion here.

I talked to a Vector-Vest tech a little while ago and he's positive that their portfolio tracker program is correct to figure the entry of a short trade as the cost basis.... What say you fellas?

[Lyehopper]

Lye,
Funny you should mention $100. I was low on cash and asked my broker to lend me $100. He said,"sure", but he only had $50 so he would give me the rest later when his wife showed up . He gave me the $50 . I took it and said "forget about the other $50, lets just call it even" he agreed, smart fellow that he was. What is my gain on this deal ? a.) we're even b.) 50% c.) 100% or
d.) infinite

biilyjoe

(E) none of the above.... You made no gain because he "lent" you the money and by definition you must pay it back at some future time.

[Lyehopper]

You can tell yourself anything you want but when you start with $100 and you end up with $120 you have $20 more. $20 / $100 + 20% gain regardless of long or short in my opinion. Less the commissions on both ends of course which will change the percentages and should be counted as part of the expenses of doing business.

Good point Ski.... Who else?

[jiesen]

(E) none of the above.... You made no gain because he "lent" you the money and by definition you must pay it back at some future time.

well, not if he forgets about it!

[IIC]

what happened to the dollar??

lets say you borrow $50 from john and another $50 from mike friend and you buy yourself an item for $97 so you have $3 change right? ok from the $3 you give $1 to john and another $1 to mike so that leaves you owing both $49 equaling to $98 and leaves you with $1.

so adding every thing up gives you $99, your missing $1.....

so heres the problem...

50+50=100
100-97=3
50-1=49
50-1=49
49+49=98
1+98=99

[billyjoe]

Lye,
Getting serious now. I'd say Quasi-Ernie thinks this way. #1 In his mind he has $100 to lose or to make money with. He makes $20. He has made 20% on his money. #2 In his mind he has $100 to lose or make more money with. He loses $20. He has lost 20% of his money, but must make 25% on his next transaction to get back to where he started. This brings up another question. Quasi has a bad string of short calls and loses 20% on each trade. How many trades can he make without going broke?

billyjoe

[billyjoe]

Doug,
Inflation took it?

billyjoe

[IIC]

Lye,
Getting serious now. I'd say Quasi-Ernie thinks this way. #1 In his mind he has $100 to lose or to make money with. He makes $20. He has made 20% on his money. #2 In his mind he has $100 to lose or make more money with. He loses $20. He has lost 20% of his money, but must make 25% on his next transaction to get back to where he started. This brings up another question. Quasi has a bad string of short calls and loses 20% on each trade. How many trades can he make without going broke?

billyjoe

If he traded QBID he could make a lot...although I rather doubt you could short it

[Rob]

Here's What "They" Say ...

According to this page on Investopedia.com, you ARE supposed to use the price of the short sale as the denominator when figuring the % gain or loss, which is not the way I have it on your spreadsheet, but it is the way we've been doing it on the POTW.

So according to these guys if you short at 100 and cover at 80 your gain is 20% and not 25%. It's kind of strange logic, and I don't fully agree with it, but I'm willing to bend if that's the way it's commonly figured.

Here's the quote from the above-linked page:

"To calculate the return on a short sale, all you need to do is calculate the difference between the proceeds from the sale and the cost to close the position. This value is then divided by the initial proceeds from the sale of the borrowed shares. If you were to short 100 shares at $50 a share, the total proceeds of the sale would be $5,000 ($50*100) and that amount would be deposited in the shorts account. If the stock fell to $30 and you closed your position, it would cost you $3,000 ($30*100), which would leave you with $2,000 in your account ($5,000-$3,000). The return that is calculated would be $2,000 divided by the initial proceeds from the sale of the borrowed shares and would be equal to a 40% return."

[Lyehopper]

well, not if he forgets about it!

They never really forget....

[Lyehopper]

Lye,
Getting serious now. I'd say Quasi-Ernie thinks this way. #1 In his mind he has $100 to lose or to make money with. He makes $20. He has made 20% on his money. #2 In his mind he has $100 to lose or make more money with. He loses $20. He has lost 20% of his money, but must make 25% on his next transaction to get back to where he started. This brings up another question. Quasi has a bad string of short calls and loses 20% on each trade. How many trades can he make without going broke?

billyjoe

I figure 41 (maybe 42) trades with all losing 20% before he's totally broke....