Operational Risks of Short Selling

Rate Risk

In order to sell short, we must expect to have shares available to lend you on settlement day, or expect to be able to borrow shares on your behalf on or prior to settlement day, in order to settle your trade. Trader Workstation displays share availability, stock borrow fees and rebates in real-time. These rates are indicative and are subject to change intra-day due to supply/demand and other market conditions. In certain cases, “General Collateral” names which have not previously accrued Hard-To-Borrow fees may become more “special,” leading to the short position holder to be charged a Hard-To-Borrow fee.

Trade and Settlement Date Gap

Before a client’s short sale order can be executed, our Securities Lending Desk locates the shares needed to fulfill the seller’s delivery obligation to the buyer and displays an indicative rate in TWS for that day.

However, brokers do not generally borrow the securities until the settlement date (when delivery to the buyer should be made), which is 2 business days after trade date (T+2). There is a risk that rates increase in the 2 days between the executed short sale and settlement date. The client will be charged the rate as it exists on the settlement date, as that is when shares are actually borrowed, thereby possibly accruing Hard-To-Borrow fees unexpectedly.

Corporate Action

Certain corporate actions including (but not limited to) mergers, tender offers, and distributions can lead to spikes in Hard-To-Borrow fees.

Announced dividends frequently lead to decreased supply and therefore higher borrow fees in the days leading up to record date. When a company issues a dividend distribution to its holders of record, a borrower of the shares as of that time is listed as the holder and therefore receives the dividend. The dividend is then “claimed” by the lender from the borrower, and credited to lender as a Payment-in-Lieu, or “PIL.” PIL’s are not considered by the IRS to be qualified dividends, so the lender may incur adverse tax consequences as a result of receiving a PIL versus a qualified dividend. As lenders recall their shares to avoid this possibility, the number of loanable shares across the market decreases, leading to a possible rate spike.

Short position holders are held liable to the long holder for distributions made by the company including (but not limited to) dividends (regular cash, special cash, shares), rights/warrants, and spin-off’s. This means that you could be liable for a substantial payment (or take on additional significant economic exposure) if you are short at the close business on the day prior to ex-dividend date.

De-listing and Trading Halts

When a company is delisted from the public markets or trading in that stock is halted by the listing exchange, traders may be unable to cover their short positions because the stock no longer trades. However, the original loan to the borrower is still on record, and can only be closed after shares are cancelled and DTC removes all positions in the shares from participants' accounts or, in the case of a trading halt, the halt is lifted. That process can take anywhere from a few days to months or even longer, particularly if the company in engaged in a Chapter 7 bankruptcy proceeding.

In the meantime, the borrower may continue to have to pay Hard-To-Borrow fees on the collateral market value based on the closing price of the last trading day. The minimum mark is $1 per share but can be much higher, depending on how and when the delisting or trading halt occurred.

Close-Out and Third-Party Recall

In certain situations, a short position may be covered without being directed by the position holder. We strive to avoid buy-in’s where possible, within the limits of its regulatory obligations. Please see the article “Overview of Short Stock Buy-Ins & Close-Outs” for more details.

Leveraged ETF and ETN

Leveraged Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN) have characteristics which may increase the likelihood of close-out and recall events occurring. The supply of shares available to borrow is influenced by a number of factors not found with shares of common stock. An overview of these factors can be found in “Special Risks Associated with ETN & Leveraged ETF Short Sales”.

Short Positions Resulting from Options

Holders of short call options can be assigned before option expiration. When the long holder of an option enters an early exercise request, the Options Clearing Corporation (OCC) allocates assignments to its members (including our members) at random. The OCC reports assignments to us on the day of the long call exercise (T) but after US market hours. As such, option assignments are reflected in our client accounts on the next business day (T+1), settling on T+2. The assignment causes a sale of the underlying stock on T, which can result in a short position if no underlying shares are held beforehand. Settled short position holders are subject to borrow fees, which can be high. Additionally, if we cannot fulfil the short sale delivery obligation due to a lack of securities lending inventory on settlement date, the short position can be subject to a closeout buy-in.

Due to T+2 settlement mechanics described previously, traditional purchases to cover a short position on T+1 will leave the account with a settled short stock position for at least 1 night (or longer in case of a weekend or holiday).

Long in-the-money Puts are automatically exercised on expiration date. A short position as a result of the exercise carries the same risks as assigned short calls.


Assignment of 100 XYZ Call without holding underlying XYZ stock

Day   Short Sale Buy to Cover Settled Short Position Borrow Fee Charged?
Monday OCC reports short call assignment to our after market hours. -100 XYZ stock Trade Date (T)   Flat No
Tuesday Call assignment and stock sale is reflected in our client’s account T+1 +100 XYZ stock Trade Date (T) Flat No
Wednesday   T+2 Settlement Date T+1 -100 Yes
Thursday     T+2 Settlement Flat No