Never having done any short selling before, all I really know about it is what I’ve read in my educational/scholarly pursuits, and have a couple practical (to me anyway) questions about it that I’ve not yet come across. I’m hoping some of you guys here could help me out or point me in the right direction to find out the info.
Obviously closing a short can be of my own volition, or the broker can call it back. How often do they call the shares back? And do many firms still do naked shorting?
Secondly, obviously there is a cost of carry, both from the interest on the loan and any divs/interest etc from the security. Are there any guidelines on how much of credit line one can have, and are the guidelines strict in terms of getting approved on margin? Does any of it change if you short sold, say $1000 in stock, but still kept a certain percentage of cash in the portfolio as collateral?
And lastly are there any specific securities where it is illegal? Specific stocks, bonds, funds etc etc?
I can’t answer the first part from my own experience… Second thing is obviously you need a margin enabled account to be able to short sell because they are taking a credit risk. So you may need to upgrade your account if you have a “cash only” account. Its generally just a matter of signing a few forms. They will automatically calculate your maximum allowed short sales along with your account balance. How much they hold back as collateral… I would assume they hold some back, but I don’t know how much and I bet its a broker by broker decision. In the few times I’ve sold short I never withdrew cash from the account while I had the short sale open.
As for shares that cannot be sold short by law… I think back in 2008/2009 the govt put rules on short selling of financials. I don’t remember if it was a complete ban or just restricted it. Short of the SEC saying “no you can’t sell this short” I don’t think there are any rules.
Hope that helps, but fair warning, I’m not a short selling guru. I haven’t sold short a stock since 2009.
To answer your first question, it simply depends on whether or not the shares are still available to borrow. If the firm goes outside the firm to borrow shares, there is a lower probability of being bought-in. Also, more liquid issues are at less of a risk to be bought in. Other factors would be the equity in the account and if you were in a low-equity scenario causing your broker to start liquidating positions.
To answer the second question, there is NO interest charged on short positions. You are not creating a debit and therefore not borrowing any funds. Margin IS still required however. As far as the credit line and how much you’re able to short, look no further than your firms margin agreement. In fact, you can find this in almost every form center on any retail broker website. In short, SMA requires 150% of the initial short. What that means is your equity PLUS the proceeds from the short sale must be at leat 150% of the “Short Stock Reserve” ie. the amount that would be required to buy back the short position at market. The ongoing position must satisfy house margin requirements which vary by firm. The firm I’m with for example has an ongoing maintenance requirement (same thing as margin req.) of 140% (40% equity) on stocks over $12.50. For stocks betwee $5-$12.50 the maintenance req. is $5/share. For stocks below $5 its $2.50/share. Stocks below $5 are not elligible to be shorted initially at my firm.
Here’s an example to clarify:
Suppose you just deposited $10k into a margin account so you could short XYZ at $20/share. This would allow you to short $20k worth of xyz or 1000 shares. So you short 1000 shares and your account now has $30k in it, $20k representing the short stock reserve I mentioned above.
Now lets suppose xyz executives announce a share buy back program and the stock jumps to $24 a share. Your account would now look like this:
short 1000 shares of xyz
Short Stock Reserve = $24*1000 = $24000
Account equity = $30,000 - $24000 = $6,000
Equity % = $6,000/$24000 = 25%
You are now in a margin call for $3,600. This is because the requirement (at our firm anyways) is 140% of the short stock reserve, which in this case is now $24000. 1.4X24k = 33.6k. Since you already have 30k in the account, you would have to deposit an additional $3,600. In reality, you can do 1 of 2 things, you can deposit a check for 3,600, or you can cover enough shares to raise the correct amount of equity.
Hope this helps. I work with this stuff every day so if you have any questions don’t hesitate to ask.
Another point worth mentioning: While there is no interest charged on short positions since a debit is not created, you are responsible for any dividends the company may pay. So if our XYZ paid a .50/share dividend and you were still short past the ex-date, you would see a debit of $500 come out of your account.
Everything mentioned above is correct except one caveat. If the security is hard to borrow you will have to pay interest on the short position. Think of companies like Herbalife and Angie’s List that have a lot of short sellers right now.