What does my broker get when I sell short?
There is a commision per transaction that goes to your broker (when you open or "sell short" and when you close out or "buy to cover" the position). Your broker also gets additional compensation in the form of rebates by securities lending firms and also as margin interest if you use margin to open or maintain your short position. This is done as follows:
Your broker will have to get the shares for you to sell on the open market so they need to borrow them from a willing lender (this is called Securities lending and is a way for a long-term shareholder to generate income from shares that will remain in the account by lending them out).
Monday, March 8, 2010
Margin call on a short position
What is a margin call?
When you buy stock on margin (i.e. when your broker lends you money to buy stocks) you need to keep a percentage of the whole position in liquid assets (i.e. cash and marginable securities) to ensure that you will pay off the loan made to you. Since what you buy with the borrowed funds is actually a security that varies in price daily, there is a possibility that the money that was loaned to you was used to buy stocks that declined in price. When this happens, since the outstanding loan is for the same amount as originally and you have started to lose money, there might be a situation where your liquid assets (cash and marginable securities) become less than the minimum required. In this case your broker will issue a margin call, indicating to you that you should deposit additional cash and marginable securities to make up for the shortfall. If you fail to do so, your broker will close out your positions bought on margin at their convenience to recover the original loan made to you.
When you buy stock on margin (i.e. when your broker lends you money to buy stocks) you need to keep a percentage of the whole position in liquid assets (i.e. cash and marginable securities) to ensure that you will pay off the loan made to you. Since what you buy with the borrowed funds is actually a security that varies in price daily, there is a possibility that the money that was loaned to you was used to buy stocks that declined in price. When this happens, since the outstanding loan is for the same amount as originally and you have started to lose money, there might be a situation where your liquid assets (cash and marginable securities) become less than the minimum required. In this case your broker will issue a margin call, indicating to you that you should deposit additional cash and marginable securities to make up for the shortfall. If you fail to do so, your broker will close out your positions bought on margin at their convenience to recover the original loan made to you.
Sunday, March 7, 2010
Forced buy-in (short position)
What is a forced buy-in?
When you initiated your short transaction, there were shares that were borrowed for you to be able to sell in the open market. Sometimes the lender of the shares will need their shares back and will call their shares back. Your broker will try to return said shares from another pool of willing lenders or from its own inventory but sometimes it will be necessary for you to buy back the shares so that they can be returned to the original lender. This is called a "forced buy-in" and is a risk you take on when initiating a short position. It is possible that your whole position or a portion of it is forced to be closed out (regardless of the current profit or loss on it).
When you initiated your short transaction, there were shares that were borrowed for you to be able to sell in the open market. Sometimes the lender of the shares will need their shares back and will call their shares back. Your broker will try to return said shares from another pool of willing lenders or from its own inventory but sometimes it will be necessary for you to buy back the shares so that they can be returned to the original lender. This is called a "forced buy-in" and is a risk you take on when initiating a short position. It is possible that your whole position or a portion of it is forced to be closed out (regardless of the current profit or loss on it).
Closing out a short position
When do I have to close out a short position?
A short position is closed out with a "buy to cover" transaction in most cases when you decide to. The only exceptions are when you are issued a "forced buy-in call" or a margin call that you didn't deposit additional funds into.
A short position is closed out with a "buy to cover" transaction in most cases when you decide to. The only exceptions are when you are issued a "forced buy-in call" or a margin call that you didn't deposit additional funds into.
Short Selling Mechanics
How do I actually short a stock?
Your broker's interface will include an optional similar to "Buy" or "Sell" which will be called something like "Short" or "Sell Short" (to open a short position) along with "Buy to cover" (to close out a short position). This can be done (broker-assisted) over the phone as well, usually for an extra fee.
Your broker's interface will include an optional similar to "Buy" or "Sell" which will be called something like "Short" or "Sell Short" (to open a short position) along with "Buy to cover" (to close out a short position). This can be done (broker-assisted) over the phone as well, usually for an extra fee.
Stocks that can be sold short
Can I short any stock I want to?
Your broker will indicate the restrictions that there are in terms of the stocks that you can short. For the most part, stocks with low stock prices will be difficult to short (or outright impossible to, depending on your broker). Also, there is a daily list of stocks that are "hard to borrow" and these ones might have additional restrictions (such as additional margin requirements).
Your broker will indicate the restrictions that there are in terms of the stocks that you can short. For the most part, stocks with low stock prices will be difficult to short (or outright impossible to, depending on your broker). Also, there is a daily list of stocks that are "hard to borrow" and these ones might have additional restrictions (such as additional margin requirements).
Short Selling Account
What type of account do I need in order to sell a stock short?
There are most likely two types of accounts that your broker will offer you: a cash and a margin account. In order to be able to short stocks you will need to have a margin account. This means that your account will be able to use funds loaned to you (at interest) by your broker. This is necessary for your broker to keep your short position open because you are going to borrow a stock, sell it and receive the proceeds from it but will still need to eventually "cover" this position by buying back to cover.
There are most likely two types of accounts that your broker will offer you: a cash and a margin account. In order to be able to short stocks you will need to have a margin account. This means that your account will be able to use funds loaned to you (at interest) by your broker. This is necessary for your broker to keep your short position open because you are going to borrow a stock, sell it and receive the proceeds from it but will still need to eventually "cover" this position by buying back to cover.
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