Although short selling -- the practice of selling borrowed shares with the hope of repaying the loan by buying back the shares at a lower price -- goes against the American belief that stocks always go up, I have long been fascinated with it. Short Stories discusses what works, what doesn't, and what some of the leading lights in shorting stocks think about its opportunities and threats. I describe possible short trades and seek your comments and questions for story ideas. I don't offer any investment advice and I don't trade on any of the posts I write.
About 13 months ago, I suggested selling short shares of NovaStar Financial (NYSE: NFI) when it traded at a split-adjusted $116 a share. If you had followed that advice, you would have made a tidy profit -- it now trades at $1.79. If you covered your position today, you'd have a return -- before adjusting for the cost of margin escrow -- of 64x your investment.
According to The Associated Press, NovaStar laid off 85% of its people last week and its stock will be delisted on Thursday. Prior to the delisting, NovaStar had claimed that Wachovia Corp. (NYSE: WB), its lender, had given it a break by lowering NovaStar's minimum required liquidity from $30 million to $22 million.
But NovaStar is effectively bankrupt, so if you did short the stock, it probably makes sense to wait until it's trading on the pink sheets where it will probably be trading in the pennies a share.
I wonder what happened to all the people who sent me comments like this 13 months ago:
Do you understand why Babson Capital has increased their position in NFI from 0 to 508,000 shares and $15m (making it one of the top 10 positions for Babson Capital aka Mass Mutual) in 2006. I think Babson would like to know more about what is motivating your AOL blog.
Shorting stocks is a dangerous game but I thought there was a good chance that NovaStar would go bankrupt so I went out on a limb 13 months ago. I hope some readers made money from that risk.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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