Question

Carol Travis had recently shorted 400 shares of Pfi zer, Inc., at $25 because of new federal regulations on Medicare. She put up half the value of the purchase or $5,000 as margin. Pfi zer stock price $ 25 Shares purchased 400 Total purchase $10,000 Margin percentage (50%) 5,000 When the stock initially fell to $23.50 on a Friday, she was really excited. Based on the 400 shares she sold short, she had a $600 profi t. However, over the weekend she clicked on PFE (Pfi zer) on her Internet Web site, www.yahoo!finance and was surprised to read a story about Pfi zer’s new drug for osteoarthritis receiving FDA approval. Since she saw the news before the market opened on Monday morning, she called her investment advisor, Kyle Turner. She told Kyle she wanted to immediately close out her short sale position at the quoted price of $23.50 that she had seen when the the market closed on the previous Friday. Her investment advisor told her that would not be possible. Because of the positive news over the weekend, the stock was likely to open at a higher value. Carol became greatly concerned and anxiously awaited seeing the Monday morning opening price for Pfi zer. She went into a mild panic attack when she saw there was a delayed opening on the stock. Her investment advisor explained there was an overload of buy orders that could not be matched with sell orders by specialists in the stock. The stock fi nally opened at 10:30 EST at $26.53. a. Based on the new stock price, how much is Carol’s current margin position? b. What is her percentage loss on her initial margin of $5,000? c. If her investment advisor told her there was a 60 percent chance Pfi zer, Inc., would go from its current price to $28 and a 40 percent chance it would ultimately fall to $21, should Carol maintain or close out her short sale position?

Answer 1

Short Sell value=$25*400=$10,000

Margin amount(50%)=10000/2=$5,000

	Share	Share price	Short sell value	Margin
At the time of short sell	400	$25	$10,000	$5,000
New stock price	400	$26.53	$10,612	$4388

Loss on initial margin:

Loss=(10612-10000)=$612

Percentage loss on initial margin=(612/5000)*100=12.24%

Expected price of the stock=0.6*28+0.4*21=$25.2

Since the expected price is lower than the current price of $26.53, she should maintain the short sale position.