The CFA material discusses the uptick rule, which was repealed a few months ago. So if its on the exam, do we stick to what’s in the material, or what is current in the real world?
good to know…my guess is that it would not be in the exam…
Just out of curiosity, the CFA materials mention that the uptick rule was set in place to avoid a spiral of shortselling by traders, which seems logical. What is in place now to stop that?
Regulation SHO is at least part of the solution. The reg provides that you can’t just start some death spiral by naked short-selling because you need to have a reasonable belief that you can locate, borrow, and deliver the stock. If this turns out to be false, there are requirements that open delivery failures be closed-out, essentially by buying the stock in the market and delivering it. Presumably, now there has to be someone willing to lend you their stock continuously so that you can create the death spiral. Of course, as the short interest grwos and delivery failures start becoming more frequent, owners of the stock are going to demand higher borrow fees. That means that a company trying to drive a stock into the ground is going to have to pay higher and higher fees and have more and more trouble locating stock.
I would think that most would argue that what’s in place to stop a spiral of shorting is technology. Information is a lot faster than when the uptick rule was created and if a stock spirals down to where it’s actually cheap, some person or computer algorhythm will find it and buy it. as for Reg SHO- great idea in theory, has helped a little bit, but needs a lot of fixing before it really becomes effective, like the market maker exemptions and grandfather clauses that exist right now. each index publishes their list and how many days a stock has been on it. if it really worked, you wouldn’t see names like NFI, CREE, OSTK, etc… on there for hundreds of days on end. it is a good start though and is putting the stock loan world in check. if ever i don’t post on AF for weeks on end, they’ve probably caught me for some shady locate… (kidding) Until then, I’m making my living off of those JDV mentioned fees above. doubt you guys will get a question on the test, but if you did, it’d be so basic that i’m sure if you’re following this string of posts at all, it’d be a cupcake.
Joey, what fees are you referring to? There are no explicit fees for short selling. Regarding SHO, naked short selling is only allowed for market makers, not for general investors. Please clarify. Dreary
bannisja Wrote: ------------------------------------------------------- > Until then, I’m making my living off of those JDV > mentioned fees above. > Are you really? I’ll bet you can make a handy living doing that but you have to have a portfolio just loaded full of crap.
I believe the fees he is referring to is the interest charged by the bank to loan the stock. The higher the demand for loanable stock the higher the rate of interest the bank will charge. I’ve heard of annualized rates of 25-30% for Reg Sho securities.
^ Right. We were short TZOO a few years ago and had lots of trouble maintaining the short when people were demanding upwards of 40%. It’s a real problem when you have a position you believe in, but you might have to keep locating new stock to short, deal with buy-ins, new and higher borrow charges, etc… Going short a stock is much harder than buying it in many cases (if you want to short QQQQ, for example, it is very easy).
Please point to a definitive source for this information. Could you clarify what interest the bank charges? I have been shorting stock for many years, and I have never heard of any fees (I know I never paid any, so that’s easy)… the only fee you pay is the commission charge for the trade, which is what you do whether going long or short. In fact, I had a broker who actually “paid” me when I shorted stock (through interest earned on the proceeds. Dreary
If the interest earned from the $ received from the short sale exceeds the interest charged by the bank for your securities borrowed you will not be charged. Also, your broker may have the securities you’re shorting in their inventory so they would not have to pay for the borrows. However, if you are shorting hard to borrow securities you should be paying for the borrow.
Dreary Wrote: ------------------------------------------------------- > Please point to a definitive source for this > information. Could you clarify what interest the > bank charges? > > I have been shorting stock for many years, and I > have never heard of any fees (I know I never paid > any, so that’s easy)… the only fee you pay is > the commission charge for the trade, which is what > you do whether going long or short. In fact, I > had a broker who actually “paid” me when I shorted > stock (through interest earned on the proceeds. > > Dreary A definitive source for this information? You mean the millions that I have seen walk out the door in borrow charges isn’t definitve enough for you? We must have some Treasury guys here. Good Treasury guys (besides being very valuable) have good sources for hard to borrow stock…
TJR, all what you say is possible, but please understand these are the unusual cases and they should not be generalized for the ommon short selling practice. Talk to any of the major brokers and they’ll tell you there is no such thing as fees for short seling. Also take a look at any account agreement and see if it mentions any such fees. JDV, you are probably confusing the millions of dollars lost in short selling with fees…those are not fees, they are trading losses. Dreary
I’m confusing them?! Say what? FYI - I’ve been risk manager for several multibillion dollar hedge funds for years and I had talks all the freaking time about borrow fees and how they figured into risk of the particular position. Paying borrow fees happens every time an investor shorts a stock. The average borrow fee for a US stock is about 100 bp/year. Nearly all stocks have borrow fees under 400 bp and probably 25% have borrow fees under 20 bp. Every time you have shorted a stock, you have paid borrow fees (the question for you to think about is how did they get those borrow fees while telling you that they weren’t charging you borrow fees? I’ll give you the answer later if you can’t figure it out but I would suggest you go look carefully at your brokerage statements for the last stock you shorted). If you have a hedge fund, you can probably short any stock you want. If you call up your retail broker and ask to short a hard-to-borrow stock, he’s just going to tell you it’s not available because he doesn’t have any and, if he did, it’s not for you. Another thing to think about is that since there are borrow fees on all stocks and your broker is free to lend any stock in your margin account (it’s in the fine print in your margin account agreement), how come you don’t get borrow fees for stock you own? Maybe you should (bannisja apparently does). Nothing like a junior finance L I candidate telling me I don’t know the difference between borrow fees and trading losses.
JDV, I looked at Ameritrade agreement and didn’t see any such fees. I would think that Ameritrade (or any broker really) should state those fees you claim are there. If you are talking about some hidden, undisclosed, and unfelt fees, then I am not that good at knowing them. I am not disputing your knowledge by the way, but I haven’t seen an official source for this, and that’s what I asked for. I appreciate your input, but I don’t think we are talking about the same thing. I am talking about fees deducted from a typical disount broker account for short selling. Rest assured that never happened in any of my 5+ different brokers I have used for years. Dreary
Dreary - I curious how AMTD would handle a situation where you are short a certain security and that security pays a dividend? In a true free market there would not be situations where securities where unable to locate. If the market behaved the way it should the premium to loan hard to borrows would increase to levels high enough to entice other investors to go long the position and loan out the shares. Also, the holders those long positions should also get a piece of that spread. I don’t see why small/new companies don’t push for this? Consider the additional incentive to owning HTBs if you could participate in the yield they generate.
Dreary - You need to think about it some more (references to academic literature about borrow fees are all over Google but here’s one if you can’t find it http://allaboutalpha.com/blog/2007/06/14/the-arms-merchants-of-13030/) You have paid lots of borrow fees. You just didn’t see them because you always used cash collateral, which stayed with the broker, which earned some interest… A fee doesn’t have to appear as a direct charge on your account to be a fee. Those brokers are crafty SOB’s. If you don’t use cash collateral (as most hedge funds would not) then you explicitly negotiate borrow fees. You get your Treasury guy to beat up their stock lending guy. TJR - I’m not sure what you mean by a true free market (do you mean a complete market?). Of course the problem is that not all stock is lendable. Lots of stock is held by corporate insiders (who don’t want people shorting their stock), in certificate form in a safe deposit box, in a brokerage account not allowing stock-lending, and a billion oter ways. I’ll bet only (totally wild guess) 30% of the world’s stock is lendable. You certainly can get a piece of the pie, you just have to be big enough. Even if you could do this, you need to think carefully about owning HTB stocks that everyone in the world wants to short. There’s almost always a reason that everyone in the world wants to short them. The games around shorting HTB stocks aren’t taught in the CFA curriculum and you can get crushed if you don’t know what you’re doing.
So the answer is that if you go to the Ameritrade website and read the rules, you will find that if you short some stock in your Ameritrade account: 1) Ameritrade only does locates among other Ameritrade accounts - this can be a big problem with buy-ins because if you borrowed the stock from the only Ameritrade customer with that stock and he sells to some non-Ameritrade customer you are bought-in (I’ll bet they have limits so this doesn’t happen much). 2) Ameritrade requires that you keep 50% maintenance margin (I think although this part was not clear to me) on short sales. This margin gets swept to various different cash accounts which pay interest that ranges from 0 - 2.1%. Further, you have to be careful about the rates you’re getting because the rates depend on the amount of money you have in the account as does the insurance (either SIPC or FDIC). In particular, to earn even 2% you are in uninsured land so you now have a risky deposit (albeit probably AA risky). T-bill interest is 4.1% or whatever and LIBOR is 5.2% and Ameritrade sweep accounts in big numbers are certainly riskier than LIBOR. So on half your money you are getting, at best, half the interest you deserve and Ameritrade is keeping the rest. And that’s if you have $200,000 or more in a cash sweep account which means you have shorted $400K worth of stock. More likely, you are earning 0.5% or so on half your money if you’re shorting stock in the $10,000 neighborhood. That means Ameritrade is keeping essentially all the interest that is owed to you on half your money. That makes the average borrow charge that Ameritrade charges the small investor somewhere north of 200 bp. There are plenty of stocks out there that I would think 200 bp was a fair borrow charge, but I’ll bet they’re not the ones that most people are shorting. I’ll bet that if we looked at the list of the top 10 stocks shorted in Ameritrade accounts they would look something like the top 10 volume stocks in the US which should have borrow charges around 20 bp. And for 200 bp you’re getting really lousy locate and maintenance services.
JDV, thanks for the pointers. Yes, I agree that for (small) individual investors, the broker keeps the proceeds from the short sale and the interest thereof for themselves, but that’s not exactly fees per se. In fact, if you open a cash account (versus a margin acount), which some people prefer, you indeed give up any interest from the cash in the account. I wouldn’t characterize that as paying fees either. TJR, regarding your questions about the treatment of dividends for a stock which you shorted, this happens quite a lot and what ends up happening is that the mount of the dividends is taken out of your account and deposited in the original owner’s acount. In fact, this happened to me a few times. Dreary
Dreary Wrote: ------------------------------------------------------- > JDV, thanks for the pointers. Yes, I agree that > for (small) individual investors, the broker keeps > the proceeds from the short sale and the interest > thereof for themselves, but that’s not exactly > fees per se. In fact, if you open a cash account > (versus a margin acount), which some people > prefer, you indeed give up any interest from the > cash in the account. I wouldn’t characterize that > as paying fees either. > We should do business! C’mon - you’re trying to be a finance professional here. Paying an outright fee or giving someone a very low interest rate loan are the same (as are giving people free options, guaranteeing credit, etc.). If it’s valuable and you give it to them, it’s a fee. > TJR, regarding your questions about the treatment > of dividends for a stock which you shorted, this > happens quite a lot and what ends up happening is > that the mount of the dividends is taken out of > your account and deposited in the original owner’s > acount. In fact, this happened to me a few > times. > Dreary