Just as the title says. I know of a company going out of business. It’s public knowledge, so no insider-tradingl. The stock is still worth about 5 cents a share, as there still should be some payout. Still, it’s going away, they’re liquidating, and so forth. Can I just short-sell every share I can borrow? If there a reason it would be a bad idea?
I tried that with Enron as an experiment although I didn’t put all that much money in it. It didn’t work but I still don’t completely understand the financial situation behind it. Short-selling is always risky no matter what. You run into the problem of efficient market theory. If anything was that easy then highly paid professionals would be all over it. Then again, you might luck out.
Many times shares in companies like the one you are describing are not available for short selling. As an example, I tried short selling GFG when its share price inexplicably rose above $0.70 in mid August despite the public knowledge that it was going to shortly be taken over by the FDIC. I could not find any brokerage companies that had shares available for shorting.
For you to be able to short a stock, in effect, some other person has to be prepared to go long on it. If you know and they know that the firm is going under, why would they let you short it?
With penny stocks, there are all sorts of pumpers and dumpers, so I don’t think finding a person willing to buy the stock would be much of a problem.
Hell Washington Mutual still trades with an average volume of over 7 million per day: Link
Please find me a brokerage that lets retail investors short penny stocks.
ScotTrade, Zecco, TD, E-trade etc all have a minimum pps of $4-5 per share to allow shorting.
And also let me point out that penny stocks are extremely volatile, even if you could find a brokerage that would let you short the shares, you’d still have to find someone to borrow the shares from in order to short the stock. And if they close their position out while you’re short, you might find your short stock being covered by your brokerage at a price that may or may not be favorable to your holdings without any notice to you… you’ll just log into your account and find your short position gone.
ETA: And lastly OP will need a margin account in order to short stocks. You cannot short stocks with a cash account.
Of note, I have shorted a stock trading at $3.40 with TD.
Yeah, the basement price will vary from brokerage to brokerage. I think we can agree a stock trading above $3 is not a penny stock. Even if the brokerage does allow short sales on penny stocks, the stock still has to be marginable with the brokerage, and there has to be shares available for borrowing.
Is it liquidating in such a fashion that there is guaranteed to be no pay-out to the equity holders? Is the liquidation absolutely guaranteed, or is there still some chance of an angel stepping in at the last minute? If there is even one chance in a hundred of a $5 per share payout, the stock will trade for 5 cents . . . and if you short it that one time in a hundred, you’ll get burned big time.
Intersting: thanks all for the info. I really didn’t quite “get” why the stock was worth even that much, as it seemed like either people would bid up the price in anticipation of a payout in liquidation (they’re doing that while it’s still worth decent coin) or just drop to half-a-cent or something.
I thought the common definition was that anything under $5.00 is considered a penny stock.
Traditionally, penny stocks refer to stocks that are below $1 pps, but the SEC defines it as less than $5. I suppose it’s a matter of perspective. How many people out on the street would consider Citibank to be a penny stock?
You don’t “find someone to borrow the shares from.” You borrow them from your broker. As long as you have money in your account to cover the s/p going higher, the broker does no flatten your positions to give those shares to someone else. Where did you get this information?
Traditionally it’s less than $5.
Since it’s a multi-billion dollar company and trades on a major exchange, not many. The same people also wouldn’t consider Citibank a penny stock if it started trading less than $1 (which it came very close to doing a few months back).
Hmm, I found this:
In all the years I’ve been shorting stocks, I’ve never had this happen to me. I’ve never heard of it happening to anyone I know, either. I’m sure the chances of this happening with a solid broker is very rare.
You are incorrect. While the broker might act as, you know, a broker, and find someone who has the shares available for borrowing and borrow them on your behalf, the transaction will not execute unless shares are actually available to be borrowed. The borrowed shares come out of someone else’s account or holdings. The broker merely locates the shares and ensures they are available for delivery.
From Wikipedia:
*Shorting stock in the U.S.
In the U.S., in order to sell stocks short, the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. This is referred to as a "locate.” Brokers have a variety of means to borrow stocks in order to facilitate locates and make good 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). Depending on specific account agreements, brokers are able to borrow stocks from their customers who own “long” positions, particularly those in “margin” accounts. In these cases, and again, depending on account agreement, and only if the customer has fully paid for the long position, the broker may or may not be able to borrow the security without the express permission of the customer; the broker must provide the customer with collateral and may or may not pay a fee to the customer. In cases where the customer has not fully paid for the long position (meaning the customer borrowed money from the broker in order to finance the purchase of the security), the broker will not need to inform the customer that the long position is being used to effect delivery of another client’s short sale.*
As for how do I know that short positions can be closed by the broker at a moment’s notice? It happened to me. A couple months back I shorted a couple thousand shares of TESS at about $11 per share. My brokerage covered my short at $8.50 a share. Why? Because the shares they borrowed were sold and they were unable to locate any other shares that were available for borrowing. At least that’s what the letter from their compliance office stated.
Thanks, every major brokerage I’ve gone through so far has told me to go pound sand when I want to short low-priced stocks.
If the brokerage cannot locate shares to short, couldn’t you buy a put option instead?
Same problem - who is going to write the option?
Options market makers.
Options market makers that wish to sell short the underlying stock in order to hedge themselves directionally have special exemptions that allow them to be “naked” short the stock. They can sell short without having to borrow shares. There are limits to this, of course.