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Risks of Short Sales

Short sale risks

What are the Operational Risks of Short Selling?

 

 

Important Risks to Consider When Borrowing Stock to Support a Short Sale

In addition to the risks noted below, please keep in mind that uncovered short positions can lead to substantial losses (or unlimited losses in the case where the price of the underlying stock continues to rise while the short position remains uncovered), Short Sale Buy Ins or Force-Closing of Short Positions may occur with little to no notice and that there are the special charges associated with hard-to-borrow securities which, in aggregate, may reduce or exceed any rebate or interest paid on short stock proceeds. Due to the significant risks involved in short selling, this investment strategy requires a very high risk tolerance and is not recommended for investors with limited investment experience. 

Please click here to learn about the short selling process: How Short Sales Work.

 

 

Dividend Income Risk

You do not get to keep the dividends on the stock that you borrow. Since you do not actually own the security that you borrowed to short, you are not entitled to the dividends that may be paid on the shares. You are obligated to pay to the lender any dividends which are paid throughout the duration of the loan period.

 

Rate Risk

In order to sell short, Place Trade (PT) must expect to have shares available to lend you on settlement day or expect to be able to borrow shares on your behalf on or prior to settlement day, in order to settle your trade. Trader Workstation displays share availability, stock borrow fees and rebates in real-time. These rates are indicative and are subject to change intra-day due to supply/demand and other market conditions. In certain cases, “General Collateral” names which have not previously accrued Hard-To-Borrow fees may become more “special,” leading to the short position holder to be charged a Hard-To-Borrow fee.
 

Trade and Settlement Date Gap

Before a customer’s short sale order can be executed, the Interactive Brokers Securities Lending Desk locates the shares needed to fulfill the seller’s delivery obligation to the buyer and displays an indicative rate in TWS for that day.
 
However, brokers do not generally borrow the securities until the settlement date (when delivery to the buyer should be made), which is 2 business days after trade date (T+2). There is a risk that rates increase in the 2 days between the executed short sale and settlement date. The customer will be charged the rate as it exists on the settlement date, as that is when shares are actually borrowed, thereby possibly accruing Hard-To-Borrow fees unexpectedly.

 

Corporate Actions

Certain corporate actions including (but not limited to) mergers, tender offers, and distributions can lead to spikes in Hard-To-Borrow fees.
 
Announced dividends frequently lead to decreased supply and therefore higher borrow fees in the days leading up to record date. When a company issues a dividend distribution to its holders of record, a borrower of the shares as of that time is listed as the holder and therefore receives the dividend. The dividend is then “claimed” by the lender from the borrower, and credited to the lender as a Payment-in-Lieu, or “PIL.” PIL’s are not considered by the IRS to be qualified dividends, so the lender may incur adverse tax consequences as a result of receiving a PIL versus a qualified dividend. As lenders recall their shares to avoid this possibility, the number of loanable shares across the market decreases, leading to a possible rate spike.
 
Short position holders are held liable to the long holder for distributions made by the company including (but not limited to) dividends (regular cash, special cash, shares), rights/warrants, and spin-offs. This means that you could be liable for a substantial payment (or take on additional significant economic exposure) if you are short at the close business on the day prior to the ex-dividend date.

 

Delisting and Trading Halts

When a company is delisted from the public markets or trading in that stock is halted by the listing exchange, traders may be unable to cover their short positions because the stock no longer trades. However, the original loan to the borrower is still on record, and can only be closed after shares are canceled and DTC removes all positions in the shares from participants' accounts or, in the case of a trading halt, the halt is lifted. That process can take anywhere from a few days to months or even longer, particularly if the company is engaged in a Chapter 7 bankruptcy proceeding.
 
In the meantime, the borrower may continue to have to pay Hard-To-Borrow fees on the collateral market value based on the closing price of the last trading day. The minimum mark is $1 per share but can be much higher, depending on how and when the delisting or trading halt occurred.
 

Close-Out and Third-Party Recall

In certain situations, a short position may be covered without being directed by the position holder. PT strives to avoid buy-in’s where possible, within the limits of its regulatory obligations. Please see the article “Overview of Short Stock Buy-Ins & Close-Outs” for more details.
 

Leveraged ETF and ETN

Leveraged Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN) have characteristics which may increase the likelihood of close-out and recall events occurring. The supply of shares available to borrow is influenced by a number of factors not found with shares of common stock. An overview of these factors can be found in “Special Risks Associated with ETN & Leveraged ETF Short Sales.”

 

 

What is a Short Sale?   Risks of Short Selling   How to Sell Short   Short Stock Buy-in Procedures   Exceptional Short Sale Regulations   Reg SHO

 

 

 

 

A list of shortable stocks searchable by symbol or CUSIP along with their indicative borrow rates may be found through the Short Stock Availability Tool which is accessible through the Tools link within Account Management.

For more information, please call us at 919-719-7200.

 

 

 

 

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All investing involves risk, including the possible loss of principal and there can be no assurance that any investment strategy will be successful.