Depending on your cost basis, your broker's margin requirements and your expected income tax rate next year and in future years, it might make sense for you to not cover your short for as long as you possibly can. At some point I plan on writing a reasonably comprehensive article on this topic (efficient allocation and management of investment equity) - for now, let me title this post...(drum roll please)...
"ZITL: Should I Cover?"
I'm in Canada, so while my brokerage rules and income tax rules are similar to those in the US, they are by no means identical. My situation, FWIW, is that I am short ZITL at an average sales price of about $11.5 per share.
If I were to cover a share today at (say) $1.25, I would realize a profit of $10.25 per share. At a marginal tax rate of roughly 40% (short sales profits in Canada are taxed at the same rate as ordinary income, which can be as high as a bit over 50%(!)), I would owe about $4.10 in income tax, which would have to be paid within the next seven months (by April of next year).
In order to stay short one share, I must maintain my brokerage's 200% margin (for stocks in the price range of 50 cents to $2.50). In the case of a $1.25 stock, 200% margin means that I must keep cash equal to the current market value of the share in a noninterest-bearing account (that's $1.25, the first 100%), plus at least an additional $1.25 of "buying power" in my account (that's the second 100%). In my case I chose to keep $1.32 worth of T-Bills, on which I earn about 4% annual interest, and which my brokerage gives a "95% margin credit", i.e., a T-Bill is 95% as good as cash, so my $1.32 of T-Bill counts as $1.25 worth of "buying power". (In actual fact I keep virtually all my brokerage account cash in the form of T Bills -- it's just that some of it is mine free and clear, and some of it is "restricted", in the sense that it is being "used" as collateral for my shorts)
In economics-speak, my opportunity cost of staying short one share is that I must have $1.32 tied up in a T Bill on which I earn a nominal amount of interest. My alternative would be to cover the short, which would not require me to keep $1.32 tied up in a T Bill anymore but would require me to pay about $4.10 in income tax within the next half year.
Since it would cost me more to get out of my short than to stay in it, I will be staying short for as long as possible, so long as present conditions remain unchanged.
If my account were at a US brokerage that required me to maintain (as I have heard) $5 of noninterest bearing cash (argh!), then I might very well consider covering, if the alternatives are to give $4.10 cash to the government or $5 to the brokerage. (Actually what I would do there is not cover but look for a better broker, one that has more sensible margin requirements!)
For US investors, an added attraction is that ZITL is unlikely to become "substantially worthless" for at least several years IMO, which would allow a US short seller to defer taxes for a good long time yet, if I understand US tax law correctly (the part about having to declare profits on a short sale in the year that the securities become "substantially worthless").
- Daniel |
