Short selling question

Ok, I know basically how short selling on the market works. i.e.-borrow securities, sell them, buy them back later and pocket the difference if the price falls.

I wonder, though, how this process is actually carried out. Where do buyers borrow the actual shares from? Is there a time limit agreed upon to repurchase and return the shares? Do the short sellers pay a premium or interest to borrow the stocks? Are the short sellers actually just purchasing put options?

Sorry about my ignorance. Thanks to all those more skilled in the realities of economic markets that can provide help.

There are no set time limits for short sales, at least none that I’ve seen, although if everyone starts selling you may be forced to repay your shares so that the “real owners” have something to sell.

One restriction on short selling is that your sell order will not be carried out until there is an uptick in the price. This is to prevent masses of short sellers from piling on a hurting stock and driving the price down even further. Another thing to consider is that if any dividends are paid out, you have to pay them yourself.

As for your first question, the best I can do is wave my hands and say “computers”. In normal market conditions, there will be lots of people buying and selling, so your brokerage will probably just make a note that while most of the customers own “positive x shares”, there are a few short sellers with “negative y shares”, and just balance them out internally.


A clarification and an addition:

The only premium that I know of is that you have to wait for the price to rise before your short sell order will be carried out.

Also, you shouldn’t be paying any interest on a short sale. If you are, you’re brokerage is acting dishonestly.

I can answer two of the three. There are three places to get shares to sell short. 1. The short seller can borrow the securities directly from the holder (and they enter into a contract) 2. A bank which holds many shares for many of its clients can lend these shares out or 3. a bank acts as an intermediary and borrows the shares from a common depositary, a company that holds lots and lots of shares for all sorts of different people and institutions.

There doesn’t have to be a time limit on the return of the borrowerd shares, but there usually is in cases 1&2, three months I believe but I may be wrong.

You pay a fee to the original holder of the shares, as well as a makewhole agreement which basically compensates the original holder of the shares should any dividends be payed out which he cannot collect.

Purchasing a put option entitles you to sell shares at a predetermined price (the strike) within a predetermined time. If you are actually holding those shares you are hedging yourself against a fall in their value, if you do not hold the underlying shares then you are speculating on a fall in the shares price and will most probably sell your options when you think the stock has reached its lowest point.

The basic difference for you is that in the Short you are betting on a drop in the stockprice, an option is a bet on the volatility of that underlying stock.

I’m only experienced in how this works in Tokyo and Hong Kong. Moonshine covered a lot of the basics.

A lot of brokerage houses have a stock borrowing desk. That is, a small group of people that either loan out or find holders of shares they can borrow from. Often used by investment banks with big equity derivative trading desks.

Of course, there are borrowing fees. Stock lenders do so to make money, and there is a small risk that the stock won’t be returned.

Depends on the borrow agreement whether or not it is a fixed time, or if they can call the stock. If this happens, you have to return the stock the same day. It really stinks if you’ve got a hedge position on, suddenly your hedge disappears because the short stock disappears, and you have to unwind the position.

Depending on the market and instrument, it is probably easier to short a stock future. You can also take positions via calls and puts. You could even create a synthetic short future (short call, long put).

For the market today, an awful lot of the short positions will be done via index futures.