Short Stock Borrowing Costs

[VTTrader]

I apologize in advance for what is probably a very simple question, but:

Can anyone outline the costs involved in borrowing stock (ie, to enter a <b>short</b> position) on margin using a plain old Reg-T margin account? Obviously there's the margin interest rate, but is there also a separate 'short stock borrow' cost as well? I ask because while I'm familiar enough with the idea of borrowing money from my broker to enter a <b>long</b> position using margin, and the annual interest rates associated with that borrowing, I'm not so clear on what I pay in interests/fees for entering a short position on margin.

Is it just the usual margin rate, or does the 'indicative rate' of which I'm reading imply some extra cost?

Again, apologies for what's probably a very simple question, but I'm relatively new to this and want to understand my costs before entering any short transactions of this sort.

As an example, assume I have $10K in my account, and want to short $15K worth of XYZ Corp. My hypothetical broker's current margin interest rate is 5%.

Thanks for any help anyone can provide.

 

[Swan Noir]

You are conceptualizing the transaction backward. While I don't trade securities anymore -- futures only -- when I did I negotiated hard for the rate my firm paid me on short sales.

When you borrow the stock you put up 50% of its value. That stock then gets sold out of your account and the money comes in to your account. Say you sell a thousand IBM @ $200 your account shows a credit of $200,000 in what was known as a "Type 3 account" when I dealt in securities.

While you do not have control of those funds -- that $200,000 along with the $100,000 you posted serve as collateral for your trade -- there is real money there at interest. In the 90's my guess is 99% of retail customers never understood that there was cash there earning a return. And even the 1% that understood wre largely passive and the broker was simply grabbing the return. I dealt with a small family partnership so I had access to the managing partner when I opened up with them and, since I was wiring in a six figure amount, I sat down with him and cut a deal.

My deal was that I got the Fed Funds rate on everything over $50.000 that was in the Type 3 account. Not quite as good a deal as a hedge fund or big trader would get but remember 99.999999% of the retail clients got zero. At you account size you will not get any interest paid you but keep in mind you pay none. Also be aware that your trade will be marked to market every day and you can (and will) be required to post more margin if the trade goes against you.

 

[VTTrader]

Quote from Swan Noir:

You are conceptualizing the transaction backward. While I don't trade securities anymore -- futures only -- when I did I negotiated hard for the rate my firm paid me on short sales.

When you borrow the stock you put up 50% of its value. That stock then gets sold out of your account and the money comes in to your account. Say you sell a thousand IBM @ $200 your account shows a credit of $200,000 in what was known as a "Type 3 account" when I dealt in securities.

While you do not have control of those funds -- that $200,000 along with the $100,000 you posted serve as collateral for your trade -- there is real money there at interest. In the 90's my guess is 99% of retail customers never understood that there was cash there earning a return. And even the 1% that understood wre largely passive and the broker was simply grabbing the return. I dealt with a small family partnership so I had access to the managing partner when I opened up with them and, since I was wiring in a six figure amount, I sat down with him and cut a deal.

My deal was that I got the Fed Funds rate on everything over $50.000 that was in the Type 3 account. Not quite as good a deal as a hedge fund or big trader would get but remember 99.999999% of the retail clients got zero. At you account size you will not get any interest paid you but keep in mind you pay none. Also be aware that your trade will be marked to market every day and you can (and will) be required to post more margin if the trade goes against you.

Swan Noir (great name, btw!), thank you very much for explaining this subject so clearly. I really appreciate your time in writing such a detailed and useful reply! It's extremely useful to me.

Thanks again!

 

[Swan Noir]

NP

Quote from VTTrader:

Swan Noir (great name, btw!), thank you very much for explaining this subject so clearly. I really appreciate your time in writing such a detailed and useful reply! It's extremely useful to me.

Thanks again!

 

[doublet83]

Quote from VTTrader:

Swan Noir (great name, btw!), thank you very much for explaining this subject so clearly. I really appreciate your time in writing such a detailed and useful reply! It's extremely useful to me.

Thanks again!

I think the issue is more the rates they charge you for hard to borrow securities. Popular shorts often cost 30%+ to borrow.

 

[Swan Noir]

That is a relatively new phenomena because "in the day" it really wasn't much of a factor. Stock loan was a profitable department but based on generating market interest rates of return. That's why I prefaced my remarks with "I don't trade securities anymore". It is just too easy for information to be dated.

Quote from doublet83:

I think the issue is more the rates they charge you for hard to borrow securities. Popular shorts often cost 30%+ to borrow.

 

[VTTrader]

Quote from doublet83:

I think the issue is more the rates they charge you for hard to borrow securities. Popular shorts often cost 30%+ to borrow.

Doublet83, thanks for that additional information. Now, here's a question that may be difficult to answer, but:

Do you (or anyone) happen to know what criteria are used to place a security on a 'hard to borrow' list, or do the criteria vary from broker to broker? Searching my own broker's site, I haven't yet come across any such information. If the criterion is something like 'less than X percent shares in the security's float are available to short, or 'less than X percent shares held in our broker client inventory are available to short', that would be useful information to know, as I could then more accurately decide which securities NOT to short (assuming my broker actually publishes such info).

Perhaps some brokers do actually publish the number of shares they hold available to short as well as any 'hard to borrow' costs?

Thanks again for your additional info.

 

[RangeTrader]

It's much simpler to just buy far ITM puts that are 3-6 months out instead of shorting a stock...

Of course the downsides are only certain stocks have good liquidity and a narrow spread in their options, and with the time decay you need the move to happen fast.

I think there are some ways to create a synthetic short(options position that acts just like a short position on shares) with options with little time decay... Not sure how, ask around...

 

[Swan Noir]

It is less a criteria than a reality. The reason very few stocks were hard to borrow in the 90's was that there were far fewer short sellers. The public invested and that meant they were always long.

The stock hits the list because it becomes had to borrow and while some firms are much better at getting there hands on what you need than others
a particular stock hitting the list is because it has become hard to find.

One of the reasons short sellers have been quicker to attack Italy's debt than "finish up" (some will object to that phrase) with Spain is that Italian bonds are easier to borrow and in general much more liquid. The fear of a short squeeze is much higher on Spanish debt issues.

Quote from VTTrader:

Do you (or anyone) happen to know what criteria are used to place a security on a 'hard to borrow' list

[/B]

 

[Steven.Davis]

There are a number of well written webpages available:
http://www.jpmorgan.com/tss/General...aging_Value_Generation_and_Risk/1256338170739
is at the top of a Google search.

Long investors can make a little extra alpha and alot of extra leverage by lending or hypothecating their static holdings. The leverage is particularly important when Fixed Income is the asset class being lent.

The lender can either advertise or have standing agreements. There are many details in terms of rates, terms, counterparty risk, and operational risk. An agent can be employed to simplifies these issues and indemnifies the parties.

Retail brokers are reluctant to incur any costs or risks on behalf of their customers. Security Lending operations to secure house profit and liquidity while exposing counterparty and operational risks to unaware customer accounts is another story (ala MF Global.) How "good" a broker is at finding shares is thus related to how much they value your account and how sophistication the accounts are that they are targeting.

From a strategic point of view, if you are long a closely held stock, it behooves you to not lend your holdings. Suppose, for example, that the security has suffered, and you and your cohorts don't wish to realize a large loss by selling. If you are also not willing to lend, then selling is limited to the float. I.e. Italian and Spanish bonds. In such a scenario, lending could be quite expensive so the indifference point is a very expensive "hard to borrow".

There is alot going on in the middle office.