ok… short selling. The short seller (1) simultaneously borrows and sells securities through a BROKER, (2) must return the securities at the request of the lender or when the short sale is closed out, and (3) must keep a portion of proceeds of the short sale on deposit with the BROKER so my fundamental question is why does a lender/broker take part in this transaction if they only earn interest on a margin deposit and a trading fee (to the broker) on what is otherwise an asset that they can’t get rid of and will be worth less than before (capital loss) once it is returned? i’m guessing it is an open market process that a lender/ broker can participate in which somewhat mitigates losses on stocks that they hold… i suppose in aggregate there are occasions this process is a net loss to a broker, but in all a profitable transaction… any experts here? is the lender typically the broker? or is the broker just the conduit?
The lender is anyone who either a) keeps stock in margin accounts where part of the margin agreement is that you let brokers lend the stock or b) people who want to lend the stock to get borrow fees. The lender of the stock participates in the process either because he doesn’t know he is participating in the process (that would be a. above) or he wants to earn borrow fees. The borrow fees in a short sale are usually included in the really crappy interest they pay on short sale proceeds that the broker keeps. In bigger volume (like between hedge funds), it’s an explicit fee.
I’ve seen mutual funds become large lenders of securities to be sold short which is evidenced by the increase in securities lending income in the mutual fund industry. Large mutual funds will always maintain some position in securities so why not lend some of the position out for additional income. Less traded, more risky equities generate higher sec lending fees and are typically not availalbe to short by all investors (e.g. have you ever tried shorting a small cap through Ameritrade ? doesn’t work too well) As for interest on margin deposit…Is that earned by the broker ? Or by the short seller…If I remember, the short seller earns the interest on proceeds from securities sold short, sometimes referred to as short rebate income ? Can anyone provide clarity surrounding this?
The short seller earns the interest paid by the broker. Check out what Ameritrade pays - I’ll bet that if you short < 25K worth of stock you get 1% interest or something. Meanwhile Ameritrade is sitting on the money from the short sale and can do whatever they want with it.
ok, but in case b) doesn’t the lender get hosed when a stock declines more than what the borrow fees generate?.. and if so, is that the norm? Of course there will be occasions when the lender does better off (i.e. when the short seller is wrong and the bet does not payoff), but in the case of a passive investor that puts up some stocks to generate borrow fees i would suspect the short seller would have a better “idea” if the stock was mispriced and more likely to capitalize on the transaction… therefore lender is more times then not worse off. Just trying to understand how this market floats.
Lenders loss is the same as its original long position. The lender can call the stock back when it wants…and sell its position.
Char-Lee Wrote: ------------------------------------------------------- > ok, but in case b) doesn’t the lender get hosed > when a stock declines more than what the borrow > fees generate?.. and if so, is that the norm? > Sure, but he was going to be hosed by owning the stock anyway. The only reason that lending hurts him is that it puts more sellers in the market (and delivery risk when he wants it back). > Of course there will be occasions when the lender > does better off (i.e. when the short seller is > wrong and the bet does not payoff), but in the > case of a passive investor that puts up some > stocks to generate borrow fees i would suspect the > short seller would have a better “idea” if the > stock was mispriced and more likely to capitalize > on the transaction… therefore lender is more > times then not worse off. > > Just trying to understand how this market floats.
the short seller is paid interest on the money kept at the broker as collateral, unless they are putting up securities as collateral, which some places will not even give you the option of doing. All depends on the broker/prime broker relationship
The short seller may be paid interest and in many retail accounts is not paid interest. When the short seller is paid interest, it is almost surely less than the market risk-free rate. The whole point of figuring out how much it costs to short a stock is in that interest rate.