Recently our Associate, Emily Van Laarhoven, gave a global presentation to our team on Short Selling - check out some highlights below!
What is short selling?
The opposite of going long, short selling is anticipating that the price of a stock is going to drop rather than go up.
In order to do this, you would need to borrow a security and then sell it on the open market, planning to buy it back later for less money.
You profit when the security drops in price, rather than when the price increases.
Why is it risky?
There is a potential for unbounded losses because there is no limit to how much the price of a stock can rise, whereas with long positions, the most that can be lost is the amount that was paid (if the price of the stock goes to $0.00).
What is a short squeeze?
If the number of people trying to short the security exceeds the available shares of the security, then we can run into a short squeeze.
Short sellers are “squeezed” out of the market.
Short sellers will struggle to borrow the security, which they need to do to avoid failing to deliver on the short sell.
If the short sellers can’t deliver on the short sell via borrowing, they are forced to buy the security (at market rates). This is called a “buy-in.”
This is likely to happen when:
Few shares available (small market cap, low float).
Borrow rates are high.
Famous examples include Game Stop in 2021, Volkswagen in 2008.
What is a locate?
Most markets have regulations requiring proof that the seller is able to acquire a security before short selling it. This evidence is called a “locate.” Locates show due diligence indicating reasonable belief the sale can be delivered.
Unlike a sell order, locates are not contracts - locates do not need to be executed. In fact, only a small percentage of locates result in orders.
Components of locate:
Amount approved.
Indicative Rate offered on that amount.
Those who wish to short sell will “shop around” for the best rates by getting locates from multiple financial institutions and then may decide to execute the short sell with the firm that offers the most competitive terms.
We hope you find this information as interesting as we do. Thank you Emily for a great presentation!