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Old 05-09-2012, 03:41 PM
robert_columbia robert_columbia is offline
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Can I make money lending my stocks to short-sellers?

So I have some stocks. I'm interested in letting them grow over the next few months/years and am not terribly interested in "playing the market" every day to try to earn (or lose) a few hundred dollars day-trading them.

I have some understanding of the concept of "short selling" a stock. The first step in this process is that the person who wishes to short-sell must first borrow the stock they wish to sell from someone who has it.

Is it possible for me to make money (more than a trivial amount) lending, say, ten thousand dollars worth of stocks to short-sellers hoping for a quick buck? Remember that right now I'm in the mood to just sit back and go long, so I think I might be OK with making, say, a 6 month no-sell commitment while my stocks are out on loan.

Is this something I should just ask my broker about? Have you ever done it? Can you even do this with retail brokers without the brokerage taking all the "rent" payments from you?

I'm talking about:

1) Legalities (e.g. are there any regulatory reasons why I couldn't do this)
2) Practicalities (e.g. will brokers actually let you do this)

I'm less interested in getting in a debate as to where the market is headed or whether or not I should or should not be going long on these stocks.

Also, what type of risk does this really involve? If the stock rises so much that the short seller goes bankrupt trying to repurchase the stocks, who ends up holding the bag? The stock lender? The stock lender's brokerage? The short seller's brokerage? The SEC? SIPC? Your mom?

Last edited by robert_columbia; 05-09-2012 at 03:45 PM..
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  #2  
Old 05-09-2012, 04:05 PM
newme newme is offline
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Why not just sell covered call options on the stock you own? Say the stock is selling now for $100/share. Sell the call option 6 months out at a strike price of say $140. If in 6 months the stock is still selling below $140, you keep the money for selling the call and you keep your shares of stock. If the stock goes over $140, you will be paid $140/share for your shares. Downside is if the stock price really soars, you lose out on any gains over $140/share.
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  #3  
Old 05-09-2012, 04:10 PM
friedo friedo is offline
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You can't really lend your shares to short sellers; they borrow what they need directly from their brokers. The traditional method for deriving extra income from shares you own is selling covered calls, as newme indicates. But this strategy is not without risk. You have to be prepared to sell your shares if the call option is in the money at expiration (or else be prepared to buy the option back before it expires.)

I experimented with covered call strategies for about a year, but I just found it exhausting to keep track of everything.

Here is a gentle introduction to covered calls.
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Old 05-10-2012, 01:07 AM
septimus septimus is offline
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(Selling covered calls may or may not be smart, but in any case is not the question OP asks.)
I was once a small retail investor with similar questions, and probably forgot (or never got) the answers, so take what I say with a dose of salt.

Quote:
Originally Posted by robert_columbia View Post
Is it possible for me to make money (more than a trivial amount) lending, say, ten thousand dollars worth of stocks to short-sellers hoping for a quick buck? ...
Also, what type of risk does this really involve?
IIRC, your broker may silently loan out your shares, with no fee to you, as part of the fine print if you open a "margin" account. In any case there would be little money in it for you, since (with the exception of dividends*) the short seller pays only a modest fee for his borrowing/sale. (Of course, such a feeless loan will carry no risk to you, unless your broker is criminal or goes completely belly-up.)

* - The short seller is responsible for reimbursing dividends on the sold stock, but of course you'd get those in any case. If shares in a subsidiary are spun off as a dividend, the mechanics might get complicated -- a good reason for a small investor to avoid loaning shares privately.

Although it's not a big issue in today's low-interest rate environment, interest on the short sale proceeds is an interesting () issue. Consider a specific example:

Suppose you can lend cash at 4%, borrow cash at 6% and Widgets Co. pays 5% dividend. For simplicity suppose the price of Widgets stock never changes (except for dividend adjustment). If you borrow money to buy Widgets, you'll lose 1% per annum. If you borrow Widgets stock to sell it and place the proceeds in an interest-paying cash account, you'll lose 1%. All symmetric, and well and good. In each case your 1% loss is, in effect, banker/broker's service fee.

But, if you are a small customer, you are unlikely to be paid interest on your short sale proceeds. In other words, the short seller in the above example would be losing 5% per annum on his money, not 1%.

This is one of several reasons why the stock market doesn't offer full value for the retail investor.
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Old 05-10-2012, 05:23 AM
Alley Dweller Alley Dweller is offline
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In the previous post, septimus brought up the issue of dividends on borrowed shares. The borrower needs to pay the dividends to the lender. However, there is a "gotcha" from the tax perspective.

In the United States, most ordinary dividends paid by corporations are what the tax code calls "qualified dividends" which means that they are subject to a maximum 15% federal income tax rate. These payments in lieu of dividends are NOT qualified dividends to the lender. They are ordinary income, taxable at ordinary rates. (Whoever holds the actual shares and receives the dividend from the corporation gets the qualified dividend treatment, whether it is the borrower or the person the borrower sold the shares to.)

Consequently, most brokerages require the borrower to pay a premium on top of the dividends and distribute the dividends plus the premium to the lender. Both the dividend (more accurately, payment in lieu of dividend) and the premium are taxable.
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  #6  
Old 05-10-2012, 10:36 AM
jbaker jbaker is offline
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From a legal and regulatory perspective, lending your shares is perfectly acceptable. The borrower will provide high-quality collateral (Treasury bills and the like) equal to at least the value of the lent securities (in the United States, usually 102%), and the amount of collateral is marked to market daily. The borrower will pay to you cash in lieu of any dividends or distributions on the borrowed securities, and you will also receive income on the collateral; depending on the scarcity of the subject securities, there may also be additional payments flowing between the borrower and the lender. This is a low-risk strategy for increasing your returns. In addition to the tax issue already mentioned by Alley Dweller. you will be unable to vote any securities that are on loan on the record date for a shareholder vote.

Of course, when I say "you," I'm assuming that you're a large institutional investor. Borrowers have no interest in going to all of this trouble for $10,000 worth of stock. So, no, as a practical matter this is not an avenue that is open to you.

In fact, as septimus mentioned, you may already be lending your holdings, without compensation. Margin account agreements generally allow the broker to lend your portfolio securities for its own benefit. This may have an effect on your ability to vote the shares, although some (not all) brokers use a process called post-reconciliation to let their margin account customers vote the lent shares anyway in most cases. I'm not sure how it's treated for tax purposes.
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