“Say what? Hedge funds do everything under the sun including lend their stocks for money.” sure, hedge funds also probably treasure hunt too but the majority (>99%) are not lenders of securities. they are borrowers.
Sure - securities lending and treasure hunting are equally popular activities for hedge funds. There is no question that most securities are lent by big banks, but hard-to-borrow stock games are hedge fund fodder.
For most people, there is no fee whatsoever for shorting stocks. I’ve been doing this for years without paying anything other than commission fees. What JDV is talking about is big funds shorting, not individual investors. In fact, I once had a broker who paid me for shorting! Go figure.
For most the fee isn’t visibly there. THe maintenance requirements on the short proceeds can be argued as indirectly costing you. I agree with you though dreary…most individual investors need not worry about it.
Individual investors won’t be able to get hard to borrow securities and HFs will pay through the nose to borrow them. And yes it is likely that you would get paid to sell short as the bank is collecting a portion of the spread between the interest earned on the cash received and cost to borrow the stock that you shorted. This would most likely occur in securities which the bank has huge long margin positions. What I’m still wondering why someone would sell stock short in the first place? I mean short selling to me is either done to hedge your portfolio or take a bearish position (bet) on a security, both of which are probably best done with derivatives. What is the fundamental reason for going out of your way and borrowing the security and then shorting it? Is it to apply pressure on the issuer by increasing the short interest? Is it to hammer away on the stock and not allow it to bid up? Is there liquidity issues at work here? Or is it mostly due to the ever declining value of derivatives due to time premium?
What derivatives are you talking about? There are: a) Put options: A put option contains a bet on volatility and time. The reason people don’t buy puts instead of shorting is theta. b) Forwards and swaps: Counterparty risk, ISDA required, legal risk, illiquid, unclear tax status. c) Futures: Only available on some stocks and not very liquid d) Exotic stuff like equity default swaps. The bank selling them can value them better than you. I know that Dreary thinks that handing off an interest-free loan to someone else isn’t costing him anything. I keep wondering why he doesn’t lend me a few hundred million that way. Shorting stocks is realtively clean and easy particularly with the extinction of the uptick rule.
Often hard to borrow securities don’t have liquid derivatives markets that allow you to take positions in size. Look at PII. Right now I’m showing a borrow of 11.5%. 15M shares are sold short, over 40% of outstanding shares. A $43 stock means nearly $650M is being put to work here. Meanwhile total outstanding interest in all put options is 15,000 contracts. If I assume the average option delta is .5 (looks reasonable), then the total dollar delta being put to work is $32M. A crude example, but I think it makes the point. Let me address a few other of your points. “Going out of your way to borrow the security”? Calling the stock loan desk, given them the order, and executing the trade takes like, 30 seconds. As you mention, options expire, and are significantly more volatile on a dollar for dollar basis. On the vast majority of stocks, hedge funds get paid to borrow them. Unlike your textbooks may make it seem, I can’t just take this cash and make it rain. It’s held as restricted cash on which you are paid a crappy interest rate (we get less than fed funds). Also, hard to borrow doesn’t necessarily mean you have to pay (or pay a lot) to borrow them, it just means you get less than your standard rate. Some of our hard to borrows we get 50 or 100 bps, some we pay a few hundred bps, and in rare cases we’ll pay 1000+ bps. As another example, TPX is also very hard to borrow, but do you think anyone who shorted it in the last 6 months cares about paying a few hundred bps given the move it has made?
there are several reasons stocks can be hard to borrow… some, for instance are hard to borrow due to a single/couple of huge owners of the underlying that will not allow the shares to be shorted. others such as supply/demand, (risk arb) can cause hard to borrow. LULU & CROX are examples of recalls where the stock is so heavily shorted that securities lending desk have to recall due to custodian supply. there are some hf that buy shorted stocks b/c they know a short squeeze could easily occur as you will find that most hard to borrow names become very volatile. as for hf’s lending shares, i just don’t get it. why would you allow other hf’s a) a view of your holdings if you are not required to file or b) other funds to short companies you own.
MFE, for hedge funds lending shares, it’s not like hedge fund a openly broadcasts, hey, I have X amount of shares long in this stock that i’m going to bid out to lend. it is done discreetly by the prime. like JDV said before, most of the time if you were a fund long and you had a valuable long, your prime would ask you about lending it. they can either lend it to other hedge funds in their world or the firm can lend stock to other firms on the street. as for why you’d let someone short a long stock you own? answer is simple. money. maybe i think CROX are stupid shoes and the fad is over, but is there a certain yield where i’d think about going long? sure. how about if i’ve been long a while and have made a nice chunk of change already and do like a stock for the long term. someone now says hey, i’m going to enhance your yield on that stock and pay you another i dunno, 4 or 5% on it annualized. maybe if you had 4 million shares and there were a 10 million share float, yeah, then maybe you’d be scared of what that short might do to the stock. but what if you had 200k shares? so you let someone sell stock in the short term… eventually they have to buy it back, right? if you’re a believer in what you own, then letting someone short your shares while you collect yield isn’t the scariest thing in the world. plus, you’re still in the driver’s seat in most of these arrangements. most of the time you won’t have to term up the stock for a contractual period. if you want to sell your long, so be it, sell it. as for the question of shorting stocks vs derivatives markets, do whichever one is more profitable and makes sense. most of the time in terms of a borrow cost, i think you’d find straight shorting a stock to be cheaper than a similar synthetic position in the options market and a lot of times more liquid depending on time frame and strike. save small buyin risk on the short or a rerate from your prime to kind of pull the rug out from under you, it probably is the “cleanest” way to get bearish on a name.
Come again? He should cancel his vacation if he gets exercised. virginCFAhooker Wrote: ------------------------------------------------------- > He’ll double his vacation if it gets exercised.
Huh? I’m long AAPL at $70. I wrote a covered call for May $180. AAPL trading at $155. If it gets to $180, I don’t see how I lose - I’ve still made $110 per share plus a hefty premium on writing the calls. AAPL isn’t getting to $180 by May 17th - it’s run up 26% over the last month.
> I know that Dreary thinks that handing off an interest-free loan to someone else isn’t > costing him anything. I keep wondering why he doesn’t lend me a few hundred million that > way. JDV, if your broker makes about 1-2% per year for your short proceeds, is that a massive cost for you? Isn’t your goal in shorting to make (I hope) more than 10%, 15%, or even 20%? What’s the big deal with your broker getting 2% out of funds that weren’t even yours? Remember, you got those proceeds by selling someone else’s shares, not your shares. Yes, for big funds that want to get a hold of a large block of shortable stock, there is a cost, but individual investors (anywhere from $10k to $2 million, I would say) have no issue with the cost of short selling.
“massive”? My goal in all my trades is to maximize my profit and minimize my risk and handing out interest free loans is a bad way to do that. In any event, your broker makes considerably more than 1-2% on your money and you should be able to do that as well. The risk free rate is > 2% and there are plenty of risks uncorrelated with short stocks with considerably higher expectation than that. Your broker of course earns commissions on the sale as well. " 2% out of funds that weren’t even yours?" is completely nuts. It sure as heck is yours because you are taking on all the risk. Big funds pay considerably less on a percentage basis for short sales except for short sales you can’t do.
Why would allowing your broker to make 1-2% on funds that could make you 10-20% profit be working against your goal of maximizing profit and minimizing risk? JDV, the funds are NOT yours, you are simply borrowing the stocks which you sold right away. By assuming some risk in the process, that is not same as saying they are your funds. They are not. You still claim that short selling costs money, but you haven’t really shown how, yet I made it very clear what goes on in the process. More importantly, I have done this for many years, and I haven’t paid what you claim I was paying! Others here have also attested to that.
Dreary - Dreary the funds are yours. Every derivative “no-arbitrage” pricing derivation in the whole world assumes that they are yours. The bigger you are, the more they are yours. I can’t imagine why you would think that they belong to the broker. The statement that you are trying to make 10-20% on a stock short “By assuming some risk in the process” is a mismatch. I am absolutely one hundred percent certain that you are not thinking about this the right way. But I’ve tried about enough. I really suggest that you think harder about this. If I don’t have enough credibility for you, I’m sorry about that.
Dreary, too many misconceptions. 1) If I take out a £10,000 loan, I get £10,000 in my bank, and a £10,000 liability. That £10,000 in my bank is as much mine as the liability is. 2) If in the same situation, they required me to pay interest on the £10,000, but I also had to keep £2,000 in a low interest account with them, that is an extra charge. A short sale is the same, it’s just that instead of interest, you are paying the return on the stock. 3) The hedgies I have talked to in the UK have a separate explicit charge for stock borrow. They hold 100% of the cash themselves (no margin required), they just pay, 30-40bps (depending on the stock) as a borrow fee. Would you rather pay a 40bps fee and get 100% of the cash, or would you rather leave 25% of your cash with the broker to receive no interest, and not be charged? Which will make you more money?
JDV, of course I trust your knowledge, but you keep making the wrong point (IMHO) about short selling. I also followed Chrismaths logic and see that both of you are making the same mistake. No one is saying there is a free lunch in America, that’s obvious. No one is saying there is no risk in stock investing, long or short. That’s obvious too. All that I am saying is that when you short a stock as an individual investor, you absolutely pay nothing (one more time NOTHING) other than your normal brokerage fees. Try this. Take out a $100k and open a margin account with any broker. Go on and short your most hated stock, and get proceeds of (lets say) $100k. Guess how much money you have in your account? Yes, you will have $200k. How much money did you invest? $100k. How much commissions did you pay? I dunno, lets say $10. Where is the extra $100k located? They are in your account. They don’t go anywhere. They always remain there, but you don’t get any interest on them, although some brokers actually pay you some little interest if that would make it any better for you. I respect your opinions, but you are wrong on interpreting how short selling works.
*shakes head ruefully*
christmaths, a better approach is to give a convincing argument, or rebut what has been argued.
You should receive the difference (or a good percentage of it) between the risk free on the 100k and the cost to borrow the security. Think about it, the firm is taking in 100k on your risk. They then earn whatever the risk free is on this 100k and leave you with the principal. The best part is that the bank has no risk because you own them the stock whether it goes up or down. The bottom line is that you should be able to do whatever you want with the proceeds of the sale of the stock. You borrowed STOCK from the bank not cash and, as such, you should only pay the bank what is the going rate for loaning that stock (which is probably less than the risk free rate for the majority of stocks).