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How to Sell Short (And Why? And When?)

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Perhaps you've read about the ban on short selling. Many believe it is one of the main causes of the current financial crisis and the fall of Bear Stearns, Lehman Brothers, and AIG. But what exactly is "short selling"? How and when can you do it? And why is it so frowned upon?

When to sell short. You sell short when you think that a certain stock price is going to fall, and you'd like to profit from that premonition.

How to sell short. Say you know something about a certain stock that nobody else does. Let's use Apple. You were a tester for the new iPhone, which you found malfunctioned. You know that upon release of the phone tomorrow, Apple's stock price will fall. You want to profit off of this, but you don't own any AAPL shares. Or you do, but not as many as you'd like.

So you borrow AAPL stock from someone else's account. Let's call him Joe. Your broker can help you do this "“ take 100 AAPL shares out of his client, Joe's, account (without Joe knowing about it) and give them to you. You sell those 100 shares at $140.90 each, today's share price. The next day the new iPhone comes out, it bombs, and as you thought, shares fall to $100. (Dramatic, yes, but go with it). The next week, you think Apple's share price will rise, so you buy back those 100 shares at $100 and give them back to Joe's account. You've just made a sweet $4,090 in profit. To sum it up: you borrow shares of stock from someone else's account. Sell them. Then buy them back at a (hopefully) lower price and return them to the account from which you borrowed.

Why sell short? One reason, as described above, is to speculate. If you think a stock or the market as a whole is overpriced, you can make money off of it. A second reason is to hedge "“ to protect yourself from unexpected losses. That is, if you're long AAPL but want to take a little less risk, you might want to short another security in the computer industry, which includes risk inherent to Apple.

You probably shouldn't sell short. Now I'm not recommending you actually do this, unless you are well versed in the markets. It's pretty risky. If Joe decides he wants to do something with these shares, he can call you on it. At that moment you'll have to cover, which means you'll have to buy back the shares you borrowed from him and put them back into his account. So "“ say AAPL price actually rose and you were called when it was $160.90. Then you would have lost $2,000.

Even if you want to, right now you can't. I also don't recommend you do this, because right now you can't. The SEC just put a ban on short-selling. After allegations that short sellers have led to the failures of Lehman, Bear, and the like, the SEC stepped in last Thursday and issued a temporary ban on short selling for 799 financial stocks. It's alleged that short sellers often use false information and conspire to drive down the price of the stock.

This isn't the first time we've placed a ban on short sellers. Short sellers were blamed for the Wall Street crash of 1929. Congress reacted by enacting a law, referred to as the "uptick rule," which banned sellers from shorting during a downturn. Sellers could not short a share when the stock was selling for lower than the previous trade. This kept short sellers from adding downward momentum of a stock when it was already sharply declining. After almost 80 years, the ban was lifted in 2007, when the SEC determined the markets were orderly enough that they didn't need the restriction (this is despite the fact that just two years prior in 2005, the SEC sought to restrict short-selling outright).

The history of short-selling takes us back earlier than the Great Depression, however. In 1609, Isaac Le Maire, a Dutch trader, made the first short. He was concerned about threats of attack by English ships and shorted shares of the Dutch East India Company, the first multinational corporation and the first company to issue stock. The Dutch stock exchange did not approve of Le Maire's actions and temporarily banned short-selling.

Later, during the Dutch depression of the 1630s, speculators saw short-selling as a means to profit off of the economic downturn. The English reacted by banning short-selling completely.

Be sure to read more of what Diana learned today here.

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iStock // Ekaterina Minaeva
Man Buys Two Metric Tons of LEGO Bricks; Sorts Them Via Machine Learning
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iStock // Ekaterina Minaeva

Jacques Mattheij made a small, but awesome, mistake. He went on eBay one evening and bid on a bunch of bulk LEGO brick auctions, then went to sleep. Upon waking, he discovered that he was the high bidder on many, and was now the proud owner of two tons of LEGO bricks. (This is about 4400 pounds.) He wrote, "[L]esson 1: if you win almost all bids you are bidding too high."

Mattheij had noticed that bulk, unsorted bricks sell for something like €10/kilogram, whereas sets are roughly €40/kg and rare parts go for up to €100/kg. Much of the value of the bricks is in their sorting. If he could reduce the entropy of these bins of unsorted bricks, he could make a tidy profit. While many people do this work by hand, the problem is enormous—just the kind of challenge for a computer. Mattheij writes:

There are 38000+ shapes and there are 100+ possible shades of color (you can roughly tell how old someone is by asking them what lego colors they remember from their youth).

In the following months, Mattheij built a proof-of-concept sorting system using, of course, LEGO. He broke the problem down into a series of sub-problems (including "feeding LEGO reliably from a hopper is surprisingly hard," one of those facts of nature that will stymie even the best system design). After tinkering with the prototype at length, he expanded the system to a surprisingly complex system of conveyer belts (powered by a home treadmill), various pieces of cabinetry, and "copious quantities of crazy glue."

Here's a video showing the current system running at low speed:

The key part of the system was running the bricks past a camera paired with a computer running a neural net-based image classifier. That allows the computer (when sufficiently trained on brick images) to recognize bricks and thus categorize them by color, shape, or other parameters. Remember that as bricks pass by, they can be in any orientation, can be dirty, can even be stuck to other pieces. So having a flexible software system is key to recognizing—in a fraction of a second—what a given brick is, in order to sort it out. When a match is found, a jet of compressed air pops the piece off the conveyer belt and into a waiting bin.

After much experimentation, Mattheij rewrote the software (several times in fact) to accomplish a variety of basic tasks. At its core, the system takes images from a webcam and feeds them to a neural network to do the classification. Of course, the neural net needs to be "trained" by showing it lots of images, and telling it what those images represent. Mattheij's breakthrough was allowing the machine to effectively train itself, with guidance: Running pieces through allows the system to take its own photos, make a guess, and build on that guess. As long as Mattheij corrects the incorrect guesses, he ends up with a decent (and self-reinforcing) corpus of training data. As the machine continues running, it can rack up more training, allowing it to recognize a broad variety of pieces on the fly.

Here's another video, focusing on how the pieces move on conveyer belts (running at slow speed so puny humans can follow). You can also see the air jets in action:

In an email interview, Mattheij told Mental Floss that the system currently sorts LEGO bricks into more than 50 categories. It can also be run in a color-sorting mode to bin the parts across 12 color groups. (Thus at present you'd likely do a two-pass sort on the bricks: once for shape, then a separate pass for color.) He continues to refine the system, with a focus on making its recognition abilities faster. At some point down the line, he plans to make the software portion open source. You're on your own as far as building conveyer belts, bins, and so forth.

Check out Mattheij's writeup in two parts for more information. It starts with an overview of the story, followed up with a deep dive on the software. He's also tweeting about the project (among other things). And if you look around a bit, you'll find bulk LEGO brick auctions online—it's definitely a thing!

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One Bite From This Tick Can Make You Allergic to Meat
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We like to believe that there’s no such thing as a bad organism, that every creature must have its place in the world. But ticks are really making that difficult. As if Lyme disease wasn't bad enough, scientists say some ticks carry a pathogen that causes a sudden and dangerous allergy to meat. Yes, meat.

The Lone Star tick (Amblyomma americanum) mostly looks like your average tick, with a tiny head and a big fat behind, except the adult female has a Texas-shaped spot on its back—thus the name.

Unlike other American ticks, the Lone Star feeds on humans at every stage of its life cycle. Even the larvae want our blood. You can’t get Lyme disease from the Lone Star tick, but you can get something even more mysterious: the inability to safely consume a bacon cheeseburger.

"The weird thing about [this reaction] is it can occur within three to 10 or 12 hours, so patients have no idea what prompted their allergic reactions," allergist Ronald Saff, of the Florida State University College of Medicine, told Business Insider.

What prompted them was STARI, or southern tick-associated rash illness. People with STARI may develop a circular rash like the one commonly seen in Lyme disease. They may feel achy, fatigued, and fevered. And their next meal could make them very, very sick.

Saff now sees at least one patient per week with STARI and a sensitivity to galactose-alpha-1, 3-galactose—more commonly known as alpha-gal—a sugar molecule found in mammal tissue like pork, beef, and lamb. Several hours after eating, patients’ immune systems overreact to alpha-gal, with symptoms ranging from an itchy rash to throat swelling.

Even worse, the more times a person is bitten, the more likely it becomes that they will develop this dangerous allergy.

The tick’s range currently covers the southern, eastern, and south-central U.S., but even that is changing. "We expect with warming temperatures, the tick is going to slowly make its way northward and westward and cause more problems than they're already causing," Saff said. We've already seen that occur with the deer ticks that cause Lyme disease, and 2017 is projected to be an especially bad year.

There’s so much we don’t understand about alpha-gal sensitivity. Scientists don’t know why it happens, how to treat it, or if it's permanent. All they can do is advise us to be vigilant and follow basic tick-avoidance practices.

[h/t Business Insider]