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How do you make money on failing companies?

by investing in the destruction of capitalism Sunday, Mar. 15, 2015 at 12:27 PM

This article is a question to the people who understand capitalism. I'll start with an explanation of what I know; you can elaborate in comments.

This article is prompted by an article about Lumber Liqudators in Seeking Alpha, and the recent closure of Exide Battery in Vernon. Companies that harm the community are at risk, and it's possible to make money by defaming them.

The popular idea about capitalism is that the only way to make money is when the value of companies (and thus, capitalism itself) is rising. However, there are some ways to make money on a stock or a commodity that's dropping in price.

The first, most direct way, is by selling. If you owned Lumber Liquidators, and sold before it dropped, you would be “profiting” by avoiding losses.

The second way is “shorting”. If you, like most people, don't own the stock, you can “short” the stock. To do this, you need a trading account with a credit line. You borrow some of the stock, and then immediately sell it. If it drops in price, you can then “cover” this loan, and take the difference as a profit. If it rises in price, you owe money.

Another way to think of it is that you sell something online, and then promise to mail it to them a month later. You don't actually own the thing – you just go to the store to buy it. If the price drops, you make more profit. If the price rises, you still need to fulfill the order, and thus, eat some of the profit.

The third way is “buying put options”. An “option” is a contract that gives you an option to buy or sell the stock at a date in the future at a specific price. The contract has a price – and the investor buys the contract, not the actual stock that's going to be bought or sold. The price of the option is a tiny fraction of the actual price, but you need to buy 1,000 at a time in a contract.

The better known option is the option to buy, which is called a “call option”. A lesser known option is the option to sell, which is called a “put option.” So, if you think that the company's stock is going to drop, you buy a put option to sell at a price higher than the expected price. The expected price in the future is called the “strike price”.

Anti-corporate and anti-capitalist activists should be looking at put options.

For example, if you don't like Wal-Mart, and are participating in actions to defame Wal-Mart, you should own some put options on Wal-Mart. If the stock price is lower than the strike price, you make money.

If the stock price is greater than the strike price, the option is worthless, and you lose the money you paid for it.

This is a link to Yahoo's options on Wal-Mart: http://finance.yahoo.com/q/op?s=WMT

You can set the expiration date of the option by clicking on the date. You can see the relationship between the strike price, expiration date, and option price. Option contracts are traded all the way to the expiration date – the price tends toward the strike price for contracts that look like sure profit, and declines as the risk increases that the contract will be worthless.

Though I don't know the mechanics of options, and haven't bought them, I suspect that owning a put option on a stock you hate will cause you to be more aggressive about saying negative things about the company.

Additionally, as a researcher of the company, you're going to know more about the company than the average person, so you can purchase the option early, and release the negative information later.

My question to the capitalists out there:

- How do you buy put options?

- What kinds of information are useful in researching potential companies to short?

- What types of underlying assets are the best things short?
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