The First Marblehead Corp (FMD)

SensibleGirl (86.42) Submitted: 10/02/06 3:11 AM

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Hi dcookie,

I'm so new to investing that it's been really exciting to watch FMD's stock price rise. Of course I know all that could change. But this company does seem headed in the right direction.

Having said that, I was wondering about a comment in a Reuters 9-27-06 blurb about FMD. The part that bothered me is copied, below. (Can you tell me what it means in plain English?)
Thanks,
SG

."...not every investor is so confident about First Marblehead-as of Aug. 8, an eye-popping 12 percent of the company's shares were sold short, in a bet the shares will decline. That high percentage of short sellers can make First Marblehead's shares jump wildly, as rising share prices force short sellers to buy shares to close out their positions. The share price reached on Wednesday was the highest since March 2005."

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dcookie (33.41) Submitted: 11/06/06 2:14 AM

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Sorry for the late reply..i haven't read caps board comments for sometime.

"12 percent of the company's shares were sold short"

I hope i can make plain english of this for you. Here goes.

The options market allows someone to bet on the short-term performance of a stock (as opposed to simply owning the stock). When someone bets >against< a stock in the options market it's called "shorting the stock" or "short-selling." Short sellers promise to deliver a given number of shares of the stock at a specific date for a given price. Thus the lower the actual stock price goes, the more money they will make when they purchase the stock to deliver on the specified date. The higher the price goes, the more they stand to loose. Practically every stock on the market has some number of shorts betting against it and short-sellers are extra skeptical of small companies ..i've no idea whether 12 percent is a large number of shorts although i would guess it is not unusual for a small cap stock. Anyway, the short sellers have a problem if the stock price begins to increase rapidly and unexpectedly. You see the mechanics of shorting require that they >will buy the stock<. Shorting is betting that they will be able to buy it at a lower price. But if the price happens to rise quickly and unexpectedly, many a short seller will freakout and buy the stock as fast as they can on the open market in order to mitigate their losses. In other words, deciding their short position will not work out, they choose to buy the stock immediately rather than risk it going even higher and making their short position even more expensive. That is why a sudden move up in a stock's price is often followed by a second wave of panic buying. It's the short-sellers way of admitting they were wrong and trying to mitigate their financial damage. That sometimes leads to even more panicky short buying..it can be a runaway train until the shorts are exhausted. Pretty messy, eh? Not to confuse things further (which i accel at) but the options market also allows people to bet the other way..that a stock will rise. Small cap stocks (like FMD) typically have a small total number of stocks out there on the market (that's called float) and if enough people are buying or selling a small cap that small float can magnify the change in cost. To a Fool like me, option trading translates into price volatility on the small cap stocks in my portfolio. It's the price of holding small caps so only buy them if you really believe in them.


Did that explain it? Sigh..I was afraid it might not. Anyway, try reading the Reuters note again, then re-reading the above paragraph and maybe there will be a moment of partial translucence. The way i take the Reuters statement is that FMD is a typical small cap with a number of skeptics shorting it and that is making it volatile especially to the upside...yippee!...because FMD is a damn good stock.

Options trading sounds like madness to me. Nonetheless, many professionals use options to reduce risk as they establish multiple trade positions in the market. They believe they've got the relevant statistics at hand to make option trading effective and obviously they can be.

Best of luck,
dc

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cdulan (93.65) Submitted: 5/29/07 7:51 PM

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DC, how about an update after the BOA and JPM purchase of SLM?

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