Short interest on big board hits a record Stated the small headlines in the Wall Street Journal (WSJ) last Friday, June 22, 2000. What does this mean to the average investor? This is analytical tracking of changes in interest charged by broker/dealer firms to investors who are shorting stock! These reports on short-selling activity have great significance to portfolio managers and active investors of all kinds. The Wall Street Journal and many Internet sites track short selling activity each market day on every individual publicly traded stock and other categories; i.e. the ten biggest company increases; the highest volume of shorting per company, biggest percentage swings in one month, etc. Abrupt changes in these numbers are indicators of investor sentiment and strategies. Rising short interest outstanding means that the bears are out prowling; the stock market is sliding downward, and the market value of many investments will drop.

Shorting stock to protect your position Several weeks ago we discussed going long and short in terms of options trading.

Options are a means to capitalise on market value swings of any stock while remaining independent of stock ownership. While not an options play, selling stock short is another risky, but favourite tactic used by many sophisticated investors. Investors who sell securities `short', borrow the stock from their broker/dealer and sell it. They are betting (for various analytical reasons) that the stock is falling in value and that they will be able to buy the shares back- at a reduced price - and return them to the broker/dealer. Even very good companies have value swings. Remember the 52-week high and low ranges on our mock portfolio. The savvy investor may choose to hold good stock for the long term but take advantage of the stock's value dips by shorting that same stock, picking up extra profit.

Example: You currently own 600 shares (MV $125 per share) of Warner-Lambert (WLA:NYSE) stock, a blue chip drug company with tremendous long-term potential. You don't want to sell the stock, as it was a gift from your grandfather. He paid almost nothing for them years ago. United States citizens and other taxpayers would want to avoid a large capital gains tax on the sale as well. WLA seems to be faltering in value due to the proposed merger with Pfizer and you think it is going to drop further. You borrow 600 shares from your broker and sell them for $125 per share. Two weeks later, the market value drops through the floor to $85 per share. You very quickly buy 600 shares at $85 per share and give them to your broker to replace those sold.

Your total profit, less the broker short interest, is nothing to sneeze at and you still own your original stock. Six weeks later the market value climbs past $125 per share and keeps going. This is capitalising on short-term value fluctuations.

Shorting is an enforceable contract The inexperienced investor should understand that shorting is not a game of chance where you walk away poorer but wiser, as at an amusement park. If you decide to play strategies such as options, short selling, margin accounts, futures, commodities, etc., you are first and foremost entering into an enforceable legal contract with the broker/dealer. The contract is similar to signing for a loan on a car, a home, etc. If you default on paying your broker, he/she can force payment by attaching your assets and affecting your credit rating. You didn't think he was going to loan it to you for free, did you? No way, this is a big money maker for brokerage firms.

Stock shares are held in street name Another interesting point, where do you think the stock comes from that the broker dealer loans you to sell short? Why from everyone else who allows their broker/dealer to hold their stock in street name. Almost all stock today is custodied at brokerage firms, not held in stock share certificates (in a safe deposit box).

There is also one other huge difference in short seller borrowing when comparing to a conventional loan. If you do not cover your position, your liability exposure can be virtually unlimited. Here's why. Question, what happens if you bet that the stock is going to drop in value and it starts to go down, but the markets rally and the stock you shorted climbs through the roof! Example: You short 600 shares of Rambus, a very small high-tech company compared to large cap Warner-Lambert, a couple of weeks ago at $60 per share thinking that it is all done, the total decline is near. As we all know, Rambus received positive news on a patent transaction, the stock rallied way, way up. Things are looking terribly, horribly bad right now. You are obligated to perform on your side of the contract. You must purchase these shares! First: Rambus is now trading at $182 per share. You do not own any of this stock, but you must replace the 600 share you borrowed. You frantically try and buy what you can wherever you can to cover your short position with your broker. The value continues to climb. Second, and now not only will these 600 shares cost you three to five times as much as what you originally shorted them for, but you cannot obtain enough of them. Rambus simply does not have enough shares out on the open market. This is known as a short squeeze! The scarcity spirals the price ever higher, $200, $350, $475 per share, will it ever stop. Never again, you say, will I speculate again! This, dear readers, is called in investor terms, going naked. And right now not only are you naked, but totally strippedof a massive amount of money.

Well, you takes your money and makes some choices; you win some, you lose some all in a day's work.

Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or any other investments. Readers needing specific assistance should seek professional advice from their financial advisor.

Martha Myron CPA is a Bermudian, a Comprehensive Financial Planner, a NASD Series 7 licensed investment broker and a US tax practitioner. She is Programming Chair for the Financial Planning Association /Bermuda. Questions regarding this article may be sent to her at 234-0290 or Email: marthamyron y northrock.bm