A beginner's guide to short-selling. Part 2
Now for some gritty details.
Borrowing shares
When I started short-selling, the most confusing thing was how one could sell something one does not own. After all, this is America.
That is exactly the reason you must first borrow the shares. But from whom? Well, from all those people who own the stock of course.
But why should they lend the stock to me? After all, I plan to sell it and hopefully the stock will go down. Well, they don't really know about it. In fact, if you own such popular shorts like BVF and NVX, it is likely that your shares have been borrowed (unless you hold the certificates).
But I didn't give my permission to lend my NVX shares in my account? Too bad, your broker lent them anyway (after he/she needs to make money too).
So, the shares that one borrows are from the pool of shares that are held in a brokerage firm in other peoples names.
Now, it should be obvious that shares can only be borrowed once otherwise the short position could be greater than the sum of shares out. That is why your broker must check to see if the firm has shares to borrow. Borrowing can be a problem at times if the short is very popular. Borrowing can also be a problem when the company has recently come public. For example, XYZ came public two months ago with a public offer of 3 million shares and a share count of 16 million. For sometime, generally six months, 13 million shares in the hands of insiders and venture capitalists is restricted and can't be sold (or borrowed). This means that only 3 million shares are potentially borrowable.
"BUYING IN"
What happens when the person who owns the shares that I borrowed wants to sell them? Do I have to give them back? Well, yes and no.
No, you don't have to give them back if your brokerage has other shares to borrow.
Yes, you have to give them back if your brokerage does not have other shares.
For example, your brokerage has a large institutional holder of BHYP and those are the only shares the brokerage is holding. Well, if that holder decides to sell all BHYP shares, then you must return the shares.
But you don't own any shares of BHYP. No problem, your broker buys them for you on the open market (at the current price). No you don't have any choice. You must surrender your shares. You have been "bought in" and lost your short position to boot.
Practically, buying in does not that often to small borrowers. It is easier for the brokerage to buy in a large short seller.
Part III later today. |
