I recently had a discussion with several traders, and none of them knew, that if you're short a stock, and the stock pays a dividend, part of your costs to be in the short position is to pay the dividend to the person you shorted the stock too. So the dividend payments, get subtracted from your total return.
Shorts, Pay The Dividend
- Thread starter calibertrader
- Start date
Of course, the dividend payments will get subtracted. However, the price of the stock should decrease by the amount of the dividend on the Ex-Div date. So, your loss from paying the dividend is offset by the gain from the drop in the stock price, when you are short the stock.
If you understand the process of shorting stocks then you understand that this is a natural consequence.
Think about it...when you short a stock there are two people who own the stock.
[1] The person who had the stock in their account and from whom you borrowed it to sell in the open market
[2] The person to whom you sold the stock (short).
The first person will receive their dividend from the company, but the second person is also long and someone has to pay the dividend that rightfully belongs to them.
That person can only be the one short the stock.
Simple, huh?
Think about it...when you short a stock there are two people who own the stock.
[1] The person who had the stock in their account and from whom you borrowed it to sell in the open market
[2] The person to whom you sold the stock (short).
The first person will receive their dividend from the company, but the second person is also long and someone has to pay the dividend that rightfully belongs to them.
That person can only be the one short the stock.
Simple, huh?
It is simple to understand, but I was surprised by how many didn't.
When you short a stock you are essentially creating a new shareholder. The person who held the shares in a margin account (the person from whom the broker borrowed the shares on the short seller's behalf) considers himself or herself a shareholder, quite justifiably. The person who bought the (lent) shares from the short seller also considers himself or herself a shareholder. Now what happens with the dividend and the vote? The company sure as heck isn't going to pay out dividends to all of these newly created shareholders, nor will it let them vote. It's actually fairly straightforward.
If and when dividends are paid, the short seller is responsible for paying those dividends to the fictitious person from whom the shares were borrowed. This is a cost of shorting. The short seller has to pay the dividend out of pocket. Of course the person who bought the shares might hold them in a margin account, so the shares might get lent out again, and so forth; but in the end, the last buyer in the chain of borrowing and shorting transactions is the one who will get the dividend from the company Tax-wise, a short seller's expense of paying a dividend to the lender is treated as a misc investment expense subject to the 2% of AGI floor. It does not affect basis (though I believe there is an exception that if a short position is open for 45 days or less, any dividends paid by the short seller are capitalized into basis instead of being treated as an investment expense -- check the latest IRS Pub 550).
Voting of shares is also affected by shorting. The old beneficial owner of a share (i.e., the person who lent it) and the new beneficial owner of the share both expect to cast the vote, but that's impossible--the company would get far more votes than shares. What I have heard is that in fact the lender loses his chance to vote the shares. The lender doesn't physically have the shares (he's not a shareholder of record) and the broker no longer physically has the shares, having lent them to the short seller (so the broker isn't a shareholder of record anymore, either). Only a shareholder-of-record can vote the shares, so that leaves the lender out. The buyer, however, does get to vote the shares. Implicit in this is that if you absolutely, positively want to guarantee your right to vote some shares, you need to ask your broker to journal them into the cash side of your account in time for the record date of the vote. If a beneficial owner whose broker lent out the shares accidentally receives the proxy materials (accidentally because the person is not entitled to them), the broker should have his computers set up to disallow that vote.
If and when dividends are paid, the short seller is responsible for paying those dividends to the fictitious person from whom the shares were borrowed. This is a cost of shorting. The short seller has to pay the dividend out of pocket. Of course the person who bought the shares might hold them in a margin account, so the shares might get lent out again, and so forth; but in the end, the last buyer in the chain of borrowing and shorting transactions is the one who will get the dividend from the company Tax-wise, a short seller's expense of paying a dividend to the lender is treated as a misc investment expense subject to the 2% of AGI floor. It does not affect basis (though I believe there is an exception that if a short position is open for 45 days or less, any dividends paid by the short seller are capitalized into basis instead of being treated as an investment expense -- check the latest IRS Pub 550).
Voting of shares is also affected by shorting. The old beneficial owner of a share (i.e., the person who lent it) and the new beneficial owner of the share both expect to cast the vote, but that's impossible--the company would get far more votes than shares. What I have heard is that in fact the lender loses his chance to vote the shares. The lender doesn't physically have the shares (he's not a shareholder of record) and the broker no longer physically has the shares, having lent them to the short seller (so the broker isn't a shareholder of record anymore, either). Only a shareholder-of-record can vote the shares, so that leaves the lender out. The buyer, however, does get to vote the shares. Implicit in this is that if you absolutely, positively want to guarantee your right to vote some shares, you need to ask your broker to journal them into the cash side of your account in time for the record date of the vote. If a beneficial owner whose broker lent out the shares accidentally receives the proxy materials (accidentally because the person is not entitled to them), the broker should have his computers set up to disallow that vote.
True, but I call that part of the efficient Theory BS. Even though it's supposed, the price still moves and the stock could still be up, in reality, i still consider it an expense. If efficient theory were true, then it wouldn't be a problem.
It is true that you need to allow three days for a trade to settle in order to collect dividend. It is not very clear though that if you sell short the exdividend day if you would have to pay the dividend even though the trade had not settled. Special one time dividend stocks will fall the next day exdividend but i have never tried this strategy. Ideas?