Donate to Remove ads

Got a credit card? use our Credit Card & Finance Calculators

Thanks to 88V8,Howard,Bhoddhisatva,penym,Anonymous, for Donating to support the site

Short selling question

Any other investment discussions eg. peer to peer lending
PinkPony
Posts: 2
Joined: January 12th, 2017, 5:23 pm

Short selling question

#165508

Postby PinkPony » September 10th, 2018, 4:04 pm

I have been wondering about a detail in my understanding of short selling. As I understand it:-

Person A wants to short the shares in XYZ plc. They borrow the shares from Person B, pay them a fee for the privilege of borrowing and then sell the shares. Assuming the price of the shares go down, Person A buys back the shares at the lower price, making a profit on the price difference. So far, so good. However, Person A now gives the shares back to Person B who ends up with a holding in XYZ plc that is worth less, possibly a lot less, than it was before the shares were lent to Person A.

How does Person B benefit from this apart from the borrowing fee which must be less than the before and after price difference? ('m working on the assumption that Person A wouldn't borrow the shares and pay a borrowing fee if they didn't think they could make a profit bigger than the cost of the borrowing fee.)

All enlightenment gratefully received.

Alaric
Lemon Quarter
Posts: 3923
Joined: November 5th, 2016, 9:05 am
Has thanked: 13 times
Been thanked: 778 times

Re: Short selling question

#165511

Postby Alaric » September 10th, 2018, 4:21 pm

PinkPony wrote:How does Person B benefit from this apart from the borrowing fee which must be less than the before and after price difference?


B just gets the fee. If B is a index tracker fund or required to tightly follow a benchmark, it has no option but to hold the shares as they fall.

Lootman
Lemon Half
Posts: 6640
Joined: November 4th, 2016, 3:58 pm
Has thanked: 43 times
Been thanked: 1047 times

Re: Short selling question

#165517

Postby Lootman » September 10th, 2018, 4:48 pm

Alaric wrote:
PinkPony wrote:How does Person B benefit from this apart from the borrowing fee which must be less than the before and after price difference?

B just gets the fee. If B is a index tracker fund or required to tightly follow a benchmark, it has no option but to hold the shares as they fall.

This is true, and in fact index funds are a major lender of shares for the simple reason that they are long-term stable holders of the shares and therefore ideal lenders of them, since they won't suddenly want them back to sell, most likely.

One other thing to note about the example is that A will owe any dividends paid to B, because those dividends will have gone to C (the buyer of the shares i.e. the other side of the short sale). But B is also entitled to them as the beneficial owner of the shares. Likewise if A borrowed the shares but did not sell them, they would get the dividend but would have to hand it over to B.

Between the fee and the dividends, it can be expensive to short.

nmdhqbc
Lemon Slice
Posts: 316
Joined: March 22nd, 2017, 10:17 am
Has thanked: 41 times
Been thanked: 83 times

Re: Short selling question

#165521

Postby nmdhqbc » September 10th, 2018, 4:55 pm

Lootman wrote:
Alaric wrote:
PinkPony wrote:How does Person B benefit from this apart from the borrowing fee which must be less than the before and after price difference?

B just gets the fee. If B is a index tracker fund or required to tightly follow a benchmark, it has no option but to hold the shares as they fall.

This is true, and in fact index funds are a major lender of shares for the simple reason that they are long-term stable holders of the shares and therefore ideal lenders of them, since they won't suddenly want them back to sell, most likely.

One other thing to note about the example is that A will owe any dividends paid to B, because those dividends will have gone to C (the buyer of the shares i.e. the other side of the short sale). But B is also entitled to them as the beneficial owner of the shares. Likewise if A borrowed the shares but did not sell them, they would get the dividend but would have to hand it over to B.

Between the fee and the dividends, it can be expensive to short.


But is the dividend really a cost? Wouldn't the share price do down by the dividend amount anyway increasing the shorts gain / reducing its loss.

Gengulphus
Lemon Quarter
Posts: 3101
Joined: November 4th, 2016, 1:17 am
Been thanked: 1609 times

Re: Short selling question

#165812

Postby Gengulphus » September 12th, 2018, 9:33 am

PinkPony wrote:How does Person B benefit from this apart from the borrowing fee which must be less than the before and after price difference? ('m working on the assumption that Person A wouldn't borrow the shares and pay a borrowing fee if they didn't think they could make a profit bigger than the cost of the borrowing fee.)

Basically, Person B wouldn't lend the shares if they wanted to be able to sell them at very short notice. I.e. they think it's a good idea to hold the shares, at least for the very short term. Person A thinks it's a good idea not to hold the shares. I say "very short" because the standard stock lending agreement does entitle the lender to call in the loan at quite short notice - something like a day IIRC. So if the lender wants to sell at merely short notice, they call in the loan and the short seller has to quickly either close their short or find another lender - short selling is not a game for those who aren't willing/able to react quickly! Equally, if a lender does that at all frequently, short sellers are going to avoid borrowing stock from them, so lending to short sellers is a game for fairly long-term holders...

Anyway, both think they're right, though of course they cannot both turn out to be right. The one who actually turns out to be right wins, the other loses... I.e. they're betting against each other - and because it's the short seller who actively wants the bet and the lender who is merely willing to accommodate the short seller for a fee, the short seller pays the lender a fee.

That assumes that the lender is the actual underlying owner of the shares. If instead the lender is a fund manager, then it's the owners of units in the fund who are betting on the share price rising and the short seller who is betting on it falling, with the fund manager just being a middleman who facilitates it all - and they get paid fees by both sides, i.e. fund management fees and stock lending fees.

Or more briefly and looking at your question in a somewhat different way, I think it is making an additional, unspoken assumption, namely an assumption that the short seller is right!

Gengulphus

Alaric
Lemon Quarter
Posts: 3923
Joined: November 5th, 2016, 9:05 am
Has thanked: 13 times
Been thanked: 778 times

Re: Short selling question

#165839

Postby Alaric » September 12th, 2018, 11:21 am

Gengulphus wrote: with the fund manager just being a middleman who facilitates it all - and they get paid fees by both sides, i.e. fund management fees and stock lending fees.


Who is ultimately paying the stock lending fees? Is it "buy and hold" investors as the shorting activity presumably dilutes the selling price of investments?

argoal
2 Lemon pips
Posts: 114
Joined: November 4th, 2016, 10:51 am
Has thanked: 13 times
Been thanked: 49 times

Re: Short selling question

#165866

Postby argoal » September 12th, 2018, 12:35 pm

Alaric wrote:
Who is ultimately paying the stock lending fees? Is it "buy and hold" investors as the shorting activity presumably dilutes the selling price of investments?


There may be a short term depression in a company's share price from short selling but ultimately the value of a share is dependent on the profits that a company makes and the stream of dividends generated from those profits.

A short squeeze, forcing the shorters to buy shares, may have the opposite effect of inflating a share price temporarily.

However ultimately short selling has little or no long term effect on the price of shares in a company therefore costs the long term investor little or nothing.

Shorting is a notoriously hard thing to get right without some form of inside information.

PinkPony
Posts: 2
Joined: January 12th, 2017, 5:23 pm

Re: Short selling question

#166947

Postby PinkPony » September 17th, 2018, 2:51 pm

Many thanks to everyone who replied. You have clarified my understanding a lot.

Cheers
PinkPony

TheMotorcycleBoy
Lemon Quarter
Posts: 2947
Joined: March 7th, 2018, 8:14 pm
Has thanked: 1387 times
Been thanked: 261 times

Re: Short selling question

#168953

Postby TheMotorcycleBoy » September 25th, 2018, 7:33 pm

PinkPony wrote:I have been wondering about a detail in my understanding of short selling. As I understand it:-

Person A wants to short the shares in XYZ plc. They borrow the shares from Person B, pay them a fee for the privilege of borrowing and then sell the shares. Assuming the price of the shares go down, Person A buys back the shares at the lower price, making a profit on the price difference. So far, so good. However, Person A now gives the shares back to Person B who ends up with a holding in XYZ plc that is worth less, possibly a lot less, than it was before the shares were lent to Person A.

How does Person B benefit from this apart from the borrowing fee which must be less than the before and after price difference? ('m working on the assumption that Person A wouldn't borrow the shares and pay a borrowing fee if they didn't think they could make a profit bigger than the cost of the borrowing fee.)

All enlightenment gratefully received.

The way I rationalise it is that there is the "lender" at the end of the chain, who already has the stock which may or may not be overvalued. They taking a business risk, that rather than selling the shares themselves, where they may well make an immediate loss; that they instead lend them out for a fee. When they get the stock back yes it may be worth more, less or the same. And they are free to retain the stock and wait for the next happy punter to come along.


Return to “Other Investing”

Who is online

Users browsing this forum: No registered users and 3 guests