Shorting a stock is about as risky a move as you can make in the market. It can be profitable, if your prediction that the stock will fall in value is correct. But your gains are limited because the best you can hope for is that the stock price goes to zero -- it can't, after all, fall any further. If you guess wrong, however, your losses could be unlimited. The higher the stock goes -- and it could theoretically go up forever -- the more it's going to cost you to buy back the shares you borrowed when you sold them short.
Two stocks that short sellers have targeted (and guessed wrong on) in the past include Shopify (NYSE:SHOP) and Trulieve Cannabis (OTC:TCNNF). And if you had followed their advice, your losses could have been significant.
E-commerce company Shopify has been one of the hottest tech stocks over the past few years. Its easy-to-use platform allows anyone to become a vendor and sell products online. In 2019, the company's sales of $1.6 billion were up 47% from the previous year. And amid the coronavirus pandemic, with people staying indoors and spending more time online, the business has been performing even better. During the nine-month period ending Sept. 30, Shopify's revenue of $1.95 billion was 81.9% higher than the same time period in the previous year.
A few years ago, in 2017, short seller Andrew Left and his company, Citron Research, weren't so convinced about Shopify's business, calling it a "get-rich-quick-scheme." They questioned how many merchants Shopify really had. The stock declined more than 11% on the day Citron released its short report, falling to below $104. Say you sold short 100 shares of Shopify the day before the Citron report. That would have cost you around $11,700. Buying them back the day after the report, when the stock fell even lower and below $100, could have cost you less than $10,000, so you'd have seen a profit of as much as $1,700 (or more). However, say you kept holding the stock -- all the way up to its current price of $1,450 per share. Fulfilling that short obligation now would cost you $145,000.
Cannabis producer Trulieve has been expanding at an incredible rate, generating sales of $353.1 million over its most recent three quarters. That's more than double the $173.1 million it reported in the prior-year period. And Trulieve continues to grow, planning to expand into its sixth state, West Virginia, this year. Currently, it has operations in Florida, Connecticut, California, Pennsylvania, and Massachusetts.
And there are many more opportunities ahead after five states passed marijuana reform in November 2020, including New Jersey, which will permit recreational use. Neighboring New York has also expressed interest in legalizing marijuana.
But despite the marijuana industry's impressive growth prospects and Trulieve's strong performance, Grizzly Research wasn't bullish about Trulieve a little over a year ago. On Dec. 17, 2019, the research company released a 26-page report calling Trulieve a fraud. Its report contained detailed analysis and pictures to support its claims and even included scandalous accusations that involved the CEO's husband and an FBI probe. Trulieve fired back, saying the report involved "rookie analysis," and took legal action against Grizzly Research. However, when the report became public, Trulieve's stock fell to a low of $9.18 and would close at $10.40 -- down 12.7% from the previous day.
If you had shorted $10,000 worth of Trulieve at $10.40 back then, you would need to buy back approximately 962 shares. As of the end of last week, the stock was trading at $47.85, meaning that would now cost you more than $46,000.
Here's what bearish investors can do instead of shorting a stock
If you think a stock is in trouble or that it will fall in value, you don't need to short it to bet against it. Using put options can be an effective way to take advantage of an overpriced stock. Put options allow you to lock in a selling price. While options may not be available for every stock, popular businesses on the top exchanges will have them. If, for instance, you think Shopify is too expensive at $1,450, you can buy put options on the stock. Then, if the stock proceeds to fall in value, you can buy it at a cheaper price and use the put option to sell the shares at a higher price point.
While options cost money and you may not end up using them, they can offer you a safer way to bet against a stock. Anytime you actually short a stock, you're taking on the risk of literally unlimited loss.