Equities · E4 · 8 min
Short selling and securities lending
Work out what a bet on a falling share costs to hold, and spot when too many people are making the same bet.
In the news: “Heavily shorted stock jumps 40%”: why traders betting on a fall can be forced to buy at the worst moment.
The essentials
- Short selling
- Selling borrowed shares and buying them back later, to profit from a fall. The most a short can make is 100%, if the share goes to zero; the loss has no limit, because the price can keep rising.
- Securities lending
- Long-term holders such as pension and index funds lend shares for a fee and hold cash or bonds as . The lender can recall the shares at any time, which can force a short to close at a bad moment.
- The cost of a short
- The borrow fee, quoted as a % a year of the value borrowed, plus every dividend paid while short. Large companies cost well under 1% a year to borrow; shares many people want to short can cost 10% or more.
- Short interest and days to cover
- is the shares sold short and not yet bought back, often given as a % of the . Over daily volume it gives : 30 million against 4 million a day is 7.5.
- Short squeeze
- A needs crowding plus a trigger, such as good news, a bid or recalls: shorts buy into a rising price and push it higher. A rising borrow fee is an early warning that lendable shares are running out.
Cost and crowding of a short
Borrow cost = fee × value × days ÷ 365
- fee
- the yearly borrow fee, in %
- value
- the value of the shares borrowed
- days
- how long the short is open
How it works
1. Selling something you don’t own
You think a share at £10 will fall. You borrow one, sell it for £10, wait, buy one back at £8 and return it. You keep the £2. That is short selling: you profit when the price falls. If the price rises instead, you have to buy back for more than you sold, and you lose.
2. Where the shares come from
The shares are borrowed from long-term holders, such as pension funds and index funds, through . The lender earns a fee and holds cash or bonds from the borrower as security. The lender can also ask for the shares back at any time, a recall, which can force the short seller to close at a bad moment.
3. The cost of borrowing
The fee is quoted as a % a year of the value borrowed. Cost = fee × value × days ÷ 365. Most large companies cost well under 1% a year to borrow. Shares that many people want to short can cost 10% a year or more. Borrowing £1m of shares at 10% for 73 days costs £1m × 10% × 73 ÷ 365 = £20,000.
4. The short seller pays the dividends
The lender still expects every dividend the company pays. So if a dividend is paid while you are short, you pay it to the lender. Short 100,000 shares through a 20p dividend and that costs you £20,000 on top of the borrow fee.
5. Losses have no ceiling
The most a short can make is 100%, if the share falls to zero. But a share can keep rising, so the possible loss has no limit. Short at £10 and a rise to £35 costs £25 a share, two and a half times the £10 you sold it for. That is why short sellers size small and watch the price closely.
6. Short interest
is the number of shares sold short and not yet bought back. Compare it with the , the shares that are actually available to trade. If 30 million shares are short out of a free float of 150 million, short interest is 20% of the float: a lot of people are betting the same way.
7. Days to cover
How long would it take short sellers to buy back? Divide short interest by the shares traded on a normal day. 30 million short with 4 million traded a day is 7.5 . The more days, the harder it is for everyone to get out together without pushing the price up.
8. Squeezes
A crowded short plus good news, a takeover bid or a wave of recalls can start a . Shorts rush to buy back, which pushes the price up, which forces more shorts to buy. GameStop in January 2021 is the best-known case. A rising borrow fee is an early warning that lenders are running out of shares.
Worked example
You short 200,000 shares at £12.50, a £2.5m position. Borrowing costs 8% a year. After 60 days you buy back at £11.00. A 20p dividend was paid while you were short.
- Price gain: (£12.50 − £11.00) × 200,000 = £300,000.
- Borrow: £2.5m × 8% × 60 ÷ 365 = £32,877.
- Dividend paid to the lender: 20p × 200,000 = £40,000.
- Net: £300,000 − £32,877 − £40,000 = £227,123.
About £227,000 profit, after £33,000 of borrow and £40,000 of dividends.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
Why is shorting more expensive than going long?
What does high short interest tell you?
Pitch me a short and tell me what could squeeze you.
Remember
Days to cover = short interest ÷ daily volume
A short pays borrow and dividends every day it is open, and the more crowded it is, the harder it is to get out.
Sources
Definitions and maths are standard textbook material; dated facts link to the sources above. Worked numbers are illustrative.