Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fin ...
, being short in an
In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...
in such a way that the investor will profit if the
Value or values may refer to:
Ethics and social
* Value (ethics) wherein said concept may be construed as treating actions themselves as abstract objects, associating value to them
** Values (Western philosophy) expands the notion of value bey ...
of the asset falls. This is the opposite of a more conventional "
Long may refer to:
* Long, characteristic of something of great duration
* Long, characteristic of something of great length
* Longitude (abbreviation: long.), a geographic coordinate
* Longa (music), note value in early music men ...
Position often refers to:
* Position (geometry), the spatial location (rather than orientation) of an entity
* Position, a job or occupation
Position may also refer to:
Games and recreation
* Position (poker), location relative to the dealer
, where the investor will profit if the value of the asset rises.
There are a number of ways of achieving a short position. The most fundamental method is "physical" selling short or short-selling, which involves borrowing assets (often
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
such as shares
) and selling them. The investor will later purchase the same number of the same type of securities in order to return them to the lender. If the
A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
has fallen in the meantime, the investor will have made a profit equal to the difference. Conversely, if the price has risen then the investor will bear a loss. The short seller must usually pay a fee to borrow the securities (charged at a particular rate over time, similar to an interest payment
), and reimburse the lender for any cash returns such as
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-inv ...
s that were due during the period of lease.
Short positions can also be achieved through futures
Option or Options may refer to:
*Option key, a key on Apple computer keyboards
* Option type, a polymorphic data type in programming languages
*Command-line option, an optional parameter to a command
*OPTIONS, an HTTP request method
, where the investor can assume an obligation or a right to sell an asset at a future date at a price that is fixed at the time the contract is created. If the price of the asset falls below the agreed price, then the asset can be bought at the lower price before immediately being sold at the higher price specified in the forward or option contract. A short position can also be achieved through certain types of swap
, such as contracts for differences
. These are agreements between two parties to pay each other the difference if the price of an asset rises or falls, under which the party that will benefit if the price falls will have a short position.
Because a short seller can incur a liability to the lender if the price rises, and because a short sale is normally done through a
A broker is a person or firm who arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither role should be confus ...
, a short seller is typically required to post margin
to its broker as collateral to ensure that any such liabilities can be met, and to post additional margin if losses begin to accrue. For analogous reasons, short positions in derivatives also usually involve the posting of margin with the counterparty
. Any failure to post margin promptly would prompt the broker or counterparty to close the position.
Short selling is an especially systematic and common practice in public securities, futures or currency markets
that are fungible
A liquid is a nearly incompressible fluid that conforms to the shape of its container but retains a (nearly) constant volume independent of pressure. As such, it is one of the four fundamental states of matter (the others being solid, gas, a ...
A short sale may have a variety of objectives. Speculator
s may sell short hoping to realize a profit on an instrument that appears overvalued, just as
Long may refer to:
* Long, characteristic of something of great duration
* Long, characteristic of something of great length
* Longitude (abbreviation: long.), a geographic coordinate
* Longa (music), note value in early music men ...
investors or speculators hope to profit from a rise in the price of an instrument that appears undervalued. Alternatively, traders or fund managers may use offsetting short positions to
A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoini ...
certain risks that exist in a long position or a portfolio.
Research indicates that banning short selling is ineffective and has negative effects on markets. Nevertheless, short selling is subject to criticism and periodically faces hostility from society and policymakers.
Physical shorting with borrowed securities
To profit from a decrease in the price of a security, a short seller can borrow the security
and sell it, expecting that it will be cheaper to repurchase in the future. When the seller decides that the time is right (or when the lender recalls the securities), the seller buys the same number of equivalent securities and returns them to the lender. The act of buying back the securities that were sold short is called covering the short, covering the position or simply covering. A short position can be covered at any time before the securities are due to be returned. Once the position is covered, the short seller is not affected by subsequent rises or falls in the price of the securities, for it already holds the securities that it will return to the lender.
The process relies on the fact that the securities (or the other assets being sold short) are fungible
. An investor therefore "borrows" securities in the same sense as one borrows cash, where the borrowed cash can be freely disposed of and different bank notes or coins can be returned to the lender. This can be contrasted with the sense in which one borrows a bicycle, where the same bicycle must be returned, not merely one that is the same model.
Because the price of a share is theoretically unlimited, the potential losses of a short-seller are also theoretically unlimited.
Worked example of a profitable short sale
Shares in ACME
Inc. currently trade at $10 per share
# A short seller borrows from a lender 100 shares of ACME Inc., and immediately sells them for a total of $1,000.
# Subsequently, the price of the shares falls to $8 per share.
# Short seller now buys 100 shares of ACME Inc. for $800.
# Short seller returns the shares to the lender, who must accept the return of the same number of shares as was lent despite the fact that the market value of the shares has decreased.
# Short seller keeps as its profit the $200 difference between the price at which the short seller sold the borrowed shares and the lower price at which the short seller purchased the equivalent shares (minus borrowing fees paid to the lender).
Worked example of a loss-making short sale
Shares in ACME Inc. currently trade at $10 per share.
# A short seller borrows 100 shares of ACME Inc., and sells them for a total of $1,000.
# Subsequently, the price of the shares rises to $25 per share.
# Short seller is required to return the shares, and is compelled to buy 100 shares of ACME Inc. for $2,500.
# Short seller returns the shares to the lender, who accepts the return of the same number of shares as was lent.
# Short seller incurs as a loss the $1,500 difference between the price at which he sold the borrowed shares and the higher price at which the short seller had to purchase the equivalent shares (plus any borrowing fees).
Synthetic shorting with derivatives
"Shorting" or "going short" (and sometimes also "short selling") also refer more broadly to any transaction used by an investor to profit from the decline in price of a borrowed asset or financial instrument. Derivatives contracts that can be used in this way include futures
Option or Options may refer to:
*Option key, a key on Apple computer keyboards
* Option type, a polymorphic data type in programming languages
*Command-line option, an optional parameter to a command
*OPTIONS, an HTTP request method
, and swaps
These contracts are typically cash-settled, meaning that no buying or selling of the asset in question is actually involved in the contract, although typically one side of the contract will be a broker that will effect a back-to-back sale of the asset in question in order to hedge their position.
The practice of short selling was likely invented in 1609 by Dutch businessman Isaac Le Maire
, a sizeable shareholder of the
Dutch East India Company
The United East India Company ( nl, Verenigde Oostindische Compagnie, the VOC) was a chartered company established on the 20th March 1602 by the States General of the Netherlands amalgamating existing companies into the first joint-stock co ...
( Vereenigde Oostindische Compagnie
or VOC in Dutch). Edward Stringham
has written extensively on the development of sophisticated contracts on the
Amsterdam Stock Exchange
Euronext Amsterdam is a stock exchange based in Amsterdam, the Netherlands. Formerly known as the Amsterdam Stock Exchange, it merged on 22 September 2000 with the Brussels Stock Exchange and the Paris Stock Exchange to form Euronext. The ...
in the seventeenth century, including short sale contracts.
Short selling can exert downward pressure on the underlying stock, driving down the price of shares of that security. This, combined with the seemingly complex and hard-to-follow tactics of the practice, has made short selling a historical target for criticism. At various times in history, governments have restricted or banned short selling.
The London banking house of Neal, James, Fordyce and Down
collapsed in June 1772, precipitating a major crisis that included the collapse of almost every private bank in Scotland, and a liquidity crisis in the two major banking centres of the world, London and Amsterdam. The bank had been speculating by shorting
East India Company
The East India Company (EIC) was an English, and later British, joint-stock company founded in 1600 and dissolved in 1874. It was formed to trade in the Indian Ocean region, initially with the East Indies (the Indian subcontinent and South ...
stock on a massive scale, and apparently using customer deposits to cover losses. It was perceived as having a magnifying effect in the violent downturn in the Dutch tulip market
in the eighteenth century. In another well-referenced example, George Soros
became notorious for "breaking the
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the English Government's banker, and still one of the bankers for the Government o ...
Black Wednesday (or the 1992 Sterling crisis) occurred on 16 September 1992 when the UK Government was forced to withdraw sterling from the European Exchange Rate Mechanism (ERM), after a failed attempt to keep its exchange rate above th ...
of 1992, when he sold short more than $10 billion worth of pounds sterling
The term ''short'' was in use from at least the mid-nineteenth century. It is commonly understood that the word "short" (i.e. 'lacking') is used because the short seller is in a deficit position with his
A broker is a person or firm who arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither role should be conf ...
. Jacob Little
, known as ''The Great Bear of Wall Street'', began shorting stocks in the United States in 1822.
Short sellers were blamed for the Wall Street Crash of 1929
Regulations governing short selling were implemented in the United States in 1929 and in 1940. Political fallout from the 1929 crash led Congress to enact a law banning short sellers from selling shares during a downtick; this was known as the uptick rule
and was in effect until 3 July 2007, when it was removed by the Securities and Exchange Commission (SEC Release No. 34-55970). President
Herbert Clark Hoover (August 10, 1874 – October 20, 1964) was an American politician who served as the 31st president of the United States from 1929 to 1933 and a member of the Republican Party, holding office during the onset of the Gre ...
condemned short sellers and even J. Edgar Hoover
said he would investigate short sellers for their role in prolonging the Depression
. A few years later, in 1949, Alfred Winslow Jones
founded a fund (that was unregulated) that bought stocks while selling other stocks short, hence hedging some of the
Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility.
There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless, the most ...
, and the hedge fund
Negative news, such as litigation against a company, may also entice professional traders to sell the stock short in hope of the stock price going down.
The dot-com bubble (dot-com boom, tech bubble, or the Internet bubble) was a stock market bubble in the late 1990s, a period of massive growth in the use and adoption of the Internet.
Between 1995 and its peak in March 2000, the Nasdaq Comp ...
, shorting a start-up company could backfire since it could be taken over at a price higher than the price at which speculators shorted. Short-sellers were forced to cover their positions at acquisition prices, while in many cases the firm often overpaid for the start-up.
Naked short selling restrictions
During the 2008 financial crisis
, critics argued that investors taking large short positions in struggling financial firms like
Lehman Brothers Holdings Inc. ( ) was an American global financial services firm founded in 1847. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, an ...
and Morgan Stanley
created instability in the stock market and placed additional downward pressure on prices. In response, a number of countries introduced restrictive regulations on short-selling in 2008 and 2009. Naked short selling
is the practice of short-selling a tradable asset without first borrowing the security or ensuring that the security can be borrowed – it was this practice that was commonly restricted.
Investors argued that it was the weakness of financial institutions, not short-selling, that drove stocks to fall.
In September 2008, the Securities Exchange Commission in the United States abruptly banned short sales, primarily in financial stocks, to protect companies under siege in the stock market. That ban expired several weeks later as regulators determined the ban was not stabilizing the price of stocks.
Temporary short-selling bans were also introduced in the United Kingdom, Germany, France, Italy and other European countries in 2008 to minimal effect.] Australia moved to ban naked short selling entirely in September 2008. [ Germany placed a ban on naked short selling of certain euro zone securities in 2010. Spain, Portugal and Italy introduced short selling bans in 2011 and again in 2012.]
During the COVID-19 pandemic
The COVID-19 pandemic, also known as the coronavirus pandemic, is an ongoing global pandemic of coronavirus disease 2019 (COVID-19) caused by severe acute respiratory syndrome coronavirus 2 (SARS-CoV-2). The novel virus was first identifie ..., shorting was severely restricted or temporarily banned, with European market watchdogs tightening the rules on short selling "in an effort to stem the historic losses arising from the coronavirus pandemic".
Worldwide, economic regulators seem inclined to restrict short selling to decrease potential downward price cascades. Investors continue to argue this only contributes to market inefficiency.
A short seller typically borrows through a
A broker is a person or firm who arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither role should be confus ..., who is usually holding the securities for another investor who owns the securities; the broker himself seldom purchases the securities to lend to the short seller. The lender does not lose the right to sell the securities while they have been lent, as the broker usually holds a large pool of such securities for a number of investors which, as such securities are fungible, can instead be transferred to any buyer. In most market conditions there is a ready supply of securities to be borrowed, held by pension funds, mutual funds and other investors.
Shorting stock in the U.S.
To sell stocks short in the U.S., the seller must arrange for a broker-dealer to confirm that it can deliver the shorted securities. This is referred to as a '' locate''. Brokers have a variety of means to borrow stocks to facilitate locates and make good on delivery of the shorted security.
The vast majority of stocks borrowed by U.S. brokers come from loans made by the leading custody banks and fund management companies (see list below). Institutions often lend out their shares to earn extra money on their investments. These institutional loans are usually arranged by the custodian who holds the securities for the institution. In an institutional stock loan, the borrower puts up cash collateral, typically 102% of the value of the stock. The cash collateral is then invested by the lender, who often rebates part of the interest to the borrower. The interest that is kept by the lender is the compensation to the lender for the stock loan.
Brokerage firms can also borrow stocks from the accounts of their own customers. Typical margin account agreements give brokerage firms the right to borrow customer shares without notifying the customer. In general, brokerage accounts are only allowed to lend shares from accounts for which customers have ''debit balances'', meaning they have borrowed from the account. SEC Rule 15c3-3 imposes such severe restrictions on the lending of shares from cash accounts or excess margin (fully paid for) shares from margin accounts that most brokerage firms do not bother except in rare circumstances. (These restrictions include that the broker must have the express permission of the customer and provide collateral or a letter of credit.)
Most brokers allow retail customers to borrow shares to short a stock only if one of their own customers has purchased the stock on margin. Brokers go through the "locate" process outside their own firm to obtain borrowed shares from other brokers only for their large institutional customers.
Stock exchanges such as the
The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed ... or the NASDAQ typically report the "short interest" of a stock, which gives the number of shares that have been ''legally'' sold short as a percent of the total float
Float may refer to:
Arts and entertainment Music Albums
* ''Float'' (Aesop Rock album), 2000
* ''Float'' (Flogging Molly album), 2008
* ''Float'' (Styles P album), 2013
* "Float" (Tim and the Glory Boys song), 2022
* "Float", by Bush .... Alternatively, these can also be expressed as the short interest ratio, which is the number of shares ''legally'' sold short as a multiple of the average daily volume. These can be useful tools to spot trends in stock price movements but for them to be reliable, investors must also ascertain the number of shares brought into existence by naked shorters. Speculators are cautioned to remember that for every share that has been shorted (owned by a new owner), a 'shadow owner' exists (i.e., the original owner) who also is part of the universe of owners of that stock, i.e., despite having no voting rights, he has not relinquished his interest and some rights in that stock.
When a security is sold, the seller is contractually obliged to deliver it to the buyer. If a seller sells a security short without owning it first, the seller must borrow the security from a third party to fulfill its obligation. Otherwise, the seller ''fails to deliver,'' the transaction does not settle, and the seller may be subject to a claim from its counterparty. Certain large holders of securities, such as a custodian or
Investment management is the professional asset management of various securities, including shareholdings, bonds, and other assets, such as real estate, to meet specified investment goals for the benefit of investors. Investors may be institutio ... firm, often lend out these securities to gain extra income, a process known as securities lending. The lender receives a fee for this service. Similarly, retail investors can sometimes make an extra fee when their broker wants to borrow their securities. This is only possible when the investor has full title
A title is one or more words used before or after a person's name, in certain contexts. It may signify either generation, an official position, or a professional or academic qualification. In some languages, titles may be inserted between the f ... of the security, so it cannot be used as collateral for margin buying.
Sources of short interest data
Time delayed short interest data (for ''legally'' shorted shares) is available in a number of countries, including the US, the UK, Hong Kong, and Spain. The number of stocks being shorted on a global basis has increased in recent years for various structural reasons (e.g., the growth of 130/30 type strategies, short or bear ETFs). The data is typically delayed; for example, the NASDAQ requires its
In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and ... member firms to report data on the 15th of each month, and then publishes a compilation eight days later.
Some market data providers (like Data Explorers and SunGard Financial Systems) believe that stock lending data provides a good proxy for short interest levels (excluding any naked short interest). SunGard provides daily data on short interest by tracking the proxy variables based on borrowing and lending data it collects.
Short selling terms
Days to Cover (DTC) is the relationship between the number of shares in a given equity that has been ''legally'' short-sold and the number of days of typical trading that it would require to 'cover' all legal short positions outstanding. For example, if there are ten million shares of XYZ Inc. that are currently legally short-sold and the average daily volume of XYZ shares traded each day is one million, it would require ten days of average trading for all legal short positions to be covered (10 million / 1 million).
Short Interest relates the number of shares in a given equity that have been legally shorted divided by the total shares outstanding for the company, usually expressed as a percent. For example, if there are ten million shares of XYZ Inc. that are currently legally short-sold, and the total number of shares issued by the company is one hundred million, the Short Interest is 10% (10 million / 100 million). If, however, shares are being created through naked short selling, "fails" data must be accessed to assess accurately the true level of short interest.
Borrow cost is the fee paid to a securities lender for borrowing the stock or other security. The cost of borrowing the stock is usually negligible compared to fees paid and interest accrued on the margin account – in 2002, 91% of stocks could be shorted for less than a 1% fee per annum, generally lower than interest rates earned on the margin account. However, certain stocks become "hard to borrow" as stockholders willing to lend their stock become more difficult to locate. The cost of borrowing these stocks can become significant – in February 2001, the cost to borrow (short)
Krispy Kreme, Inc. (previously Krispy Kreme Doughnuts, Inc.) is an American multinational doughnut company and coffeehouse chain.
Krispy Kreme was founded by Vernon Rudolph (1915–1973), who bought a yeast-raised recipe from a New Orleans c ... stock reached an annualized 55%, indicating that a short seller would need to pay the lender more than half the price of the stock over the course of the year, essentially as interest for borrowing a stock in limited supply. This has important implications for derivatives pricing and strategy, for the borrow cost itself can become a significant convenience yield for holding the stock (similar to additional dividend
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-inv ...) – for instance, put–call parity relationships are broken and the early exercise feature of American call options on non-dividend paying stocks can become rational to exercise early, which otherwise would not be economical.
* State Street Corporation (Boston, United States)
Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment banki ... (New Jersey, United States)
* JP Morgan Chase
JPMorgan Chase & Co. is an American multinational investment bank and financial services holding company headquartered in New York City and incorporated in Delaware. As of 2022, JPMorgan Chase is the largest bank in the United States, t ... (New York, United States)
* Northern Trust
Northern Trust Corporation is a financial services company headquartered in Chicago that caters to corporations, institutional investors, and ultra high net worth individuals. Northern Trust is one of the largest banking institutions in the Uni ... (Chicago, United States)
* Fortis (Amsterdam, Netherlands, now defunct)
* ABN AMRO (Amsterdam, Netherlands, formerly Fortis)
* Citibank (New York, United States)
* Bank of New York Mellon Corporation (New York, United States)
* UBS AG (Zurich, Switzerland)
Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services.
Barclays traces ... (London, United Kingdom)
Naked short selling
A naked short sale occurs when a security is sold short without borrowing the security within a set time (for example, three days in the US.) This means that the buyer of such a short is buying the short-seller's promise to deliver a share, rather than buying the share itself. The short-seller's promise is known as a hypothecated share.
When the holder of the underlying stock receives a dividend, the holder of the hypothecated share would receive an equal
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-inv ... from the short seller.
Naked shorting has been made illegal except where allowed under limited circumstances by market maker
A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the '' bid–ask spread'', or ''turn.'' The benefit to the firm is that i ...s. It is detected by the Depository Trust & Clearing Corporation
The Depository Trust & Clearing Corporation (DTCC) is an American post-trade financial services company providing clearing and settlement services to the financial markets. It performs the exchange of securities on behalf of buyers and selle ... (in the US) as a " failure to deliver" or simply "fail." While many fails are settled in a short time, some have been allowed to linger in the system.
In the US, arranging to borrow a security before a short sale is called a ''locate''. In 2005, to prevent widespread failure to deliver securities, the U.S. Securities and Exchange Commission (SEC) put in place Regulation SHO, intended to prevent speculators from selling some stocks short before doing a locate. More stringent rules were put in place in September 2008, ostensibly to prevent the practice from exacerbating market declines. These rules were made permanent in 2009.
When a broker facilitates the delivery of a client's short sale, the client is charged a fee for this service, usually a standard commission similar to that of purchasing a similar security.
If the short position begins to move against the holder of the short position (i.e., the price of the security begins to rise), money is removed from the holder's cash balance and moved to their margin balance. If short shares continue to rise in price, and the holder does not have sufficient funds in the cash account to cover the position, the holder begins to borrow on margin for this purpose, thereby accruing margin interest charges. These are computed and charged just as for any other margin debit. Therefore, only margin accounts can be used to open a short position.
When a security's
The ex-dividend date, also known as the reinvestment date, is an investment term involving the timing of payment of dividends on stocks of corporations, income trusts, and other financial holdings, both publicly and privately held. The ex-date or ... passes, the dividend is deducted from the shortholder's account and paid to the person from whom the stock is borrowed.
For some brokers, the short seller may not earn interest on the proceeds of the short sale or use it to reduce outstanding margin debt. These brokers may not pass this benefit on to the retail client unless the client is very large. The interest is often split with the lender of the security.
Dividends and voting rights
Where shares have been shorted and the company that issues the shares distributes a dividend, the question arises as to who receives the dividend. The new buyer of the shares, who is the ''holder of record'' and holds the shares outright, receives the dividend from the company. However, the lender, who may hold its shares in a margin account with a prime broker and is unlikely to be aware that these particular shares are being lent out for shorting, also expects to receive a dividend. The short seller therefore pays the lender an amount equal to the dividend to compensate—though technically, as this payment does not come from the company, it is not a dividend. The short seller is therefore said to be ''short the dividend''.
A similar issue comes up with the voting rights attached to the shorted shares. Unlike a dividend, voting rights cannot legally be synthesized and so the buyer of the shorted share, as the holder of record, controls the voting rights. The owner of a margin account from which the shares were lent agreed in advance to relinquish voting rights to shares during the period of any short sale.
As noted earlier, victims of naked shorting sometimes report that the number of votes cast is greater than the number of shares issued by the company.
Transactions in financial derivatives such as options and futures have the same name but have different overlaps, one notable overlap is having an equal "negative" amount in the position. However, the practice of a short position in derivatives is completely different. Derivatives are contracts between two parties, a buyer and seller. Each trade results in a "long" (buyer's position) and a "short" (seller's position).
Futures and options contracts
In finance, a futures contract (sometimes called a futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset ...s, being 'short' means having the legal obligation to deliver something at the expiration of the contract, although the holder of the short position may alternately buy back the contract prior to expiration instead of making delivery. Short futures transactions are often used by producers of a commodity to fix the future price of goods they have not yet produced. Shorting a futures contract is sometimes also used by those holding the underlying asset (i.e. those with a long position) as a temporary hedge against price declines. Shorting futures may also be used for speculative trades, in which case the investor is looking to profit from any decline in the price of the futures contract prior to expiration.
An investor can also purchase a put option, giving that investor the right (but not the obligation) to sell the underlying asset (such as shares of stock) at a fixed price. In the event of a market decline, the option holder may exercise these put options, obliging the counterparty to buy the underlying asset at the agreed upon (or "strike") price, which would then be higher than the current quoted spot price of the asset.
Selling short on the currency markets is different from selling short on the stock markets. Currencies are traded in pairs, each currency being priced in terms of another. In this way, selling short on the currency markets is identical to going long on stocks.
Novice traders or stock traders can be confused by the failure to recognize and understand this point: a contract is always long in terms of one medium and short another.
When the exchange rate has changed, the trader buys the first currency again; this time he gets more of it, and pays back the loan. Since he got more money than he had borrowed initially, he makes money. The reverse can also occur.
An example of this is as follows: Let us say a trader wants to trade with the US dollar and the
The Indian rupee (symbol: ₹; code: INR) is the official currency in the republic of India. The rupee is subdivided into 100 ''paise'' (singular: ''paisa''), though as of 2022, coins of denomination of 1 rupee are the lowest value in use wher ... currencies. Assume that the current market rate is US$1 to Rs. 50 and the trader borrows Rs. 100. With this, he buys US$2. If the next day, the conversion rate becomes US$1 to Rs. 51, then the trader sells his US$2 and gets Rs. 102. He returns Rs. 100 and keeps the Rs. 2 profit (minus fees).
One may also take a short position in a currency using futures or options; the preceding method is used to bet on the spot price, which is more directly analogous to selling a stock short.
Note: this section does not apply to currency markets.
Short selling is sometimes referred to as a "negative income investment strategy" because there is no potential for dividend income or interest income. Stock is held only long enough to be sold pursuant to the contract, and one's return is therefore limited to short term
Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares.
...s, which are taxed as ordinary income. For this reason, buying shares (called "going long") has a very different risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environme ... profile from selling short. Furthermore, a "long's" losses are limited because the price can only go down to zero, but gain
Gain or GAIN may refer to:
Science and technology
* Gain (electronics), an electronics and signal processing term
* Antenna gain
* Gain (laser), the amplification involved in laser emission
* Gain (projection screens)
* Information gain in de ...s are not, as there is no limit, in theory, on how high the price can go. On the other hand, the short seller's possible gains are limited to the original price of the stock, which can only go down to zero, whereas the loss potential, again in theory, has no limit. For this reason, short selling probably is most often used as a hedge
A hedge or hedgerow is a line of closely spaced shrubs and sometimes trees, planted and trained to form a barrier or to mark the boundary of an area, such as between neighbouring properties. Hedges that are used to separate a road from adjoini ... strategy to manage the risks of long investments.
Many short sellers place a '' stop order'' with their stockbroker after selling a stock short—an order to the brokerage to cover the position if the price of the stock should rise to a certain level. This is to limit the loss and avoid the problem of unlimited liability described above. In some cases, if the stock's price skyrockets, the stockbroker may decide to cover the short seller's position immediately and without his consent to guarantee that the short seller can make good on his debt of shares.
Short sellers must be aware of the potential for a short squeeze. When the price of a stock rises significantly, some people who are shorting the stock cover their positions to limit their losses (this may occur in an automated way if the short sellers had stop-loss orders in place with their brokers); others may be forced to close their position to meet a margin call
''Margin Call'' is a 2011 American drama film written and directed by J. C. Chandor in his feature directorial debut. The principal story takes place over a 24-hour period at a large Wall Street investment bank during the initial stages of the ...; others may be forced to cover, subject to the terms under which they borrowed the stock, if the person who lent the stock wishes to sell and take a profit. Since covering their positions involves buying shares, the short squeeze causes an ever further rise in the stock's price, which in turn may trigger additional covering. Because of this, most short sellers restrict their activities to heavily traded stocks, and they keep an eye on the "short interest" levels of their short investments. Short interest is defined as the total number of shares that have been ''legally'' sold short, but not covered. A short squeeze can be deliberately induced. This can happen when large investors (such as companies or wealthy individuals) notice significant short positions, and buy many shares, with the intent of selling the position at a profit to the short sellers, who may be panicked by the initial uptick or who are forced to cover their short positions to avoid margin calls.
Another risk is that a given stock may become "hard to borrow". As defined by the SEC and based on lack of availability, a broker may charge a hard to borrow fee daily, without notice, for any day that the SEC declares a share is hard to borrow. Additionally, a broker may be required to cover a short seller's position at any time ("buy in"). The short seller receives a warning from the broker that he is "failing to deliver" stock, which leads to the buy-in.
Because short sellers must eventually deliver the shorted securities to their broker, and need money to buy them, there is a credit risk for the broker. The penalties for failure to deliver on a short selling contract inspired financier Daniel Drew to warn: "He who sells what isn't his'n, Must buy it back or go to pris'n." To manage its own risk, the broker requires the short seller to keep a margin account, and charges interest of between 2% and 8% depending on the amounts involved.
In 2011, the eruption of the massive China stock frauds on North American equity markets brought a related risk to light for the short seller. The efforts of research-oriented short sellers to expose these frauds eventually prompted NASDAQ, NYSE and other exchanges to impose sudden, lengthy trading halts that froze the values of shorted stocks at artificially high values. Reportedly in some instances, brokers charged short sellers excessively large amounts of interest based on these high values as the shorts were forced to continue their borrowings at least until the halts were lifted.
Short sellers tend to temper overvaluation by selling into exuberance. Likewise, short sellers are said to provide price support by buying when negative sentiment is exacerbated after a significant price decline. Short selling can have negative implications if it causes a premature or unjustified share price collapse when the fear of cancellation due to bankruptcy becomes contagious.
Hedging often represents a means of minimizing the risk from a more complex set of transactions.
Examples of this are:
* A farmer who has just planted their wheat wants to lock in the price at which they can sell after the harvest. The farmer would take a short position in wheat futures.
A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the '' bid–ask spread'', or ''turn.'' The benefit to the firm is that i ... in corporate bond
A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of ...s is constantly trading bonds when clients want to buy or sell. This can create substantial bond positions. The largest risk is that interest rates overall move. The trader can hedge this risk by selling government bonds short against his long positions in corporate bonds. In this way, the risk that remains is credit risk
A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased co ... of the corporate bonds.
* An options trader may short shares to remain delta neutral so that they are not exposed to risk from price movements in the stocks that underlie their options
A short seller may be trying to benefit from market inefficiencies arising from the mispricing of certain products. Examples of this are
* An arbitrageur who buys long futures contracts on a US Treasury security, and sells short the underlying US Treasury security.
Against the box
One variant of selling short involves a long position. "Selling short against the box" consists of holding a long position on which the shares have already risen, whereupon one then enters a short sell order for an equal number of shares. The term ''box'' alludes to the days when a safe deposit box was used to store (long) shares. The purpose of this technique is to lock in paper profits on the long position without having to sell that position (and possibly incur taxes if said position has appreciated). Once the short position has been entered, it serves to balance the long position taken earlier. Thus, from that point in time, the profit is locked in (less brokerage fees and short financing costs), regardless of further fluctuations in the underlying share price. For example, one can ensure a profit in this way, while delaying sale until the subsequent tax year.
U.S. investors considering entering into a "short against the box" transaction should be aware of the tax consequences of this transaction. Unless certain conditions are met, the IRS deems a "short against the box" position to be a "constructive sale" of the long position, which is a taxable event. These conditions include a requirement that the short position be closed out within 30 days of the end of the year and that the investor must hold their long position, without entering into any hedging strategies, for a minimum of 60 days after the short position has been closed.
Securities Exchange Act of 1934
The Securities Exchange Act of 1934 (also called the Exchange Act, '34 Act, or 1934 Act) (, codified at et seq.) is a law governing the secondary trading of securities (stocks, bonds, and debentures) in the United States of America. A landm ... gave the Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market ... the power to regulate short sales. The first official restriction on short selling came in 1938, when the SEC adopted a rule (known as the uptick rule) that a short sale could only be made when the price of a particular stock was higher than the previous trade price. The uptick rule aimed to prevent short sales from causing or exacerbating market price declines. In January 2005, The Securities and Exchange Commission enacted Regulation SHO to target abusive naked short selling. Regulation SHO was the SEC's first update to short selling restrictions since the uptick rule in 1938.
The regulation contains two key components: the "locate" and the "close-out". The locate component attempts to reduce failure to deliver securities by requiring a broker possess or have arranged to possess borrowed shares. The close out component requires that a broker be able to deliver the shares that are to be shorted. In the US, initial public offers (IPOs) cannot be sold short for a month after they start trading. This mechanism is in place to ensure a degree of price stability during a company's initial trading period. However, some brokerage firms that specialize in penny stock
Penny stocks are common shares of small public companies that trade for less than one dollar per share.
The U.S. Securities and Exchange Commission (SEC) uses the term "Penny stock" to refer to a security, a financial instrument which represents ...s (referred to colloquially as bucket shops) have used the lack of short selling during this month to pump and dump
Pump and dump (P&D) is a form of securities fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price. Once the operat ... thinly traded IPOs
In demonology, Ipos is an Earl and powerful Prince of Hell (a Duke to some authors) who has thirty-six legions of demons under his command. He knows and can reveal all things, past, present and future (only the future to some authors, and past an .... Canada and other countries do allow selling IPOs (including U.S. IPOs) short.
The Securities and Exchange Commission initiated a temporary ban on short selling of 799 financial stocks from 19 September 2008 until 2 October 2008. Greater penalties for naked shorting, by mandating delivery of stocks at clearing time, were also introduced. Some state governors have been urging state pension bodies to refrain from lending stock for shorting purposes. An assessment of the effect of the temporary ban on short-selling in the United States and other countries in the wake of the financial crisis showed that it had only "little impact" on the movements of stocks, with stock prices moving in the same way as they would have moved anyhow, but the ban reduced volume and liquidity.
Europe, Australia and China
In the UK, the Financial Services Authority had a moratorium on short selling of 29 leading financial stocks, effective from 2300
Greenwich Mean Time (GMT) is the mean solar time at the Royal Observatory in Greenwich, London, counted from midnight. At different times in the past, it has been calculated in different ways, including being calculated from noon; as a cons ... on 19 September 2008 until 16 January 2009. After the ban was lifted, John McFall, chairman of the Treasury Select Committee, House of Commons
The House of Commons is the name for the elected lower house of the bicameral parliaments of the United Kingdom and Canada. In both of these countries, the Commons holds much more legislative power than the nominally upper house of parliament. ..., made clear in public statements and a letter to the FSA that he believed it ought to be extended. Between 19 and 21 September 2008, Australia temporarily banned short selling, and later placed an indefinite ban on naked short selling. Australia's ban on short selling was further extended for another 28 days on 21 October 2008. Also during September 2008, Germany, Ireland, Switzerland and Canada banned short selling of leading financial stocks, and France, the Netherlands
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Belgium, ; french: Belgique ; german: Belgien officially the Kingdom of Belgium, is a country in Northwestern Europe. The country is bordered by the Netherlands to the north, Germany to the east, Luxembourg to the southeast, France to th ... banned naked short selling of leading financial stocks. By contrast with the approach taken by other countries, Chinese regulators responded by allowing short selling, along with a package of other market reforms. Short selling was completely allowed on 31 March 2010, limited to " for large blue chip stocks with good earnings performance and little price volatility." However, in 2015, short selling was effectively banned due to legislative restrictions on borrowing stocks following the stock market crash the same year.
Views of short selling
Advocates of short selling argue that the practice is an essential part of the
In economics and finance, the price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers.
Price discovery is diff ... mechanism. Financial researchers at Duke University said in a study that short interest is an indicator of poor future stock performance (the self-fulfilling aspect) and that short sellers exploit market mistakes about firms' fundamentals.
Such noted investors as Seth Klarman and Warren Buffett have said that short sellers help the market. Klarman argued that short sellers are a useful counterweight to the widespread bullishness on Wall Street, while Buffett believes that short sellers are useful in uncovering fraudulent accounting and other problems at companies.
Shortseller James Chanos received widespread publicity when he was an early critic of the accounting practices of Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. It was founded by Kenneth Lay in 1985 as a merger between Lay's Houston Natural Gas and InterNorth, both relatively small regional compan .... Chanos responds to critics of short-selling by pointing to the critical role they played in identifying problems at Enron, Boston Market and other "financial disasters" over the years. In 2011, research oriented short sellers were widely acknowledged for exposing the China stock frauds.
Commentator Jim Cramer has expressed concern about short selling and started a petition calling for the reintroduction of the uptick rule. Books like ''Don't Blame the Shorts'' by Robert Sloan and ''Fubarnomics'' by Robert E. Wright suggest Cramer exaggerated the costs of short selling and underestimated the benefits, which may include the ex ante identification of asset
In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ... bubbles.
Individual short sellers have been subject to criticism and even litigation. Manuel P. Asensio, for example, engaged in a lengthy legal battle with the pharmaceutical manufacturer Hemispherx Biopharma.
Several studies of the effectiveness of short selling bans indicate that short selling bans do not contribute to more moderate market dynamics. [Beber A. and Pagano M. (2009) "Short-selling bans around the world: Evidence from the 2007–09 crisis". CSEF Working Papers 241, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.] [Kerbl S (2010]
"Regulatory Medicine Against Financial Market Instability: What Helps And What Hurts?"
* Anthony Elgindy
The Big Short
''The Big Short: Inside the Doomsday Machine'' is a nonfiction book by Michael Lewis about the build-up of the United States housing bubble during the 2000s. It was released on March 15, 2010, by W. W. Norton & Company. It spent 28 weeks on '' ...''
* Inverse exchange-traded fund
An inverse exchange-traded fund is an exchange-traded fund (ETF), traded on a public stock market, which is designed to perform as the ''inverse'' of whatever index or benchmark it is designed to track. These funds work by using short selling, tra ...
* James Chanos
* Joseph Parnes
* Magnetar Capital
* Manuel P. Asensio
* Repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
* Sharia and securities trading
The Islamic banking and finance movement that developed in the late 20th century as part of the revival of Islamic identity Usmani, ''Introduction to Islamic Finance'', 1998: p. 6 sought to create an alternative to conventional banking that com ...
* Short squeeze
* Socially responsible investing
Socially responsible investing (SRI), social investment, sustainable socially conscious, "green" or ethical investing, is any investment strategy which seeks to consider both financial return and social/environmental good to bring about socia ...
In finance, a straddle strategy involves two transactions in options on the same underlying, with opposite positions. One holds long risk, the other short. As a result, it involves the purchase or sale of particular option derivatives that all ...
General and cited references
* Fleckner, Andreas M.
Regulating Trading Practices
in ''The Oxford Handbook of Financial Regulation'' (Oxford: Oxford University Press, 2015). .
* Sloan, Robert. ''Don't Blame the Shorts: Why Short Sellers Are Always Blamed for Market Crashes and Why History Is Repeating Itself'' (New York: McGraw-Hill Professional, 2009). .
* Wright, Robert E. ''Fubarnomics: A Lighthearted, Serious Look at America's Economic Ills'' (Buffalo, N.Y.: Prometheus, 2010). .
Global Investment Technology, Sept. 29, 2008
Stock market terminology