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ative amount of the instrument. A short sale may be mo- tivated by a variety of objectives. Speculators may sell short in the hope of realizing a profit on an instrument which appears to be overvalued, just as or speculators hope to profit from a rise in the of an instrument which appears undervalued. Traders or fund managers may a long or a portfolio through one or more short positions.

1 1 CCoonncceepptt

Schematic representation of short selling in two steps. The short The following example describes the short sale of a secu- seller borrows shares and immediatelylysellsthem. The shortseller r rirityty. InIn orordederr toto prprofiofitt ffroromm aa dedecrcreaeasese inin ththee prpricicee ofof aa sese-- then expects the price to decrease, when the seller can profit by curity, a shortt selsellerler can borrow the anandd sesellll itit exex-- purchasing the shares to return to the lender. pecting that it will be cheaper to repurchase in the future. When thethesesellllerer dedecicidedess thathatt thethetimee isis ririghghtt (or(or whwhenen thethe lenlender recallslls thethe securitirities), thethe selsellerler buyss equivivalealentnt se-se- In finance, short selling (also known as shorting or or go- curities and returns them to the lender. The process relies ing short) is the practice of selling securities or other on the fact that the securities (or the other being financial instruments that are not currently owned, and sold short) are fungible; the term “borrowing” is there- subsequently repurchasinsing thethem (“coververing”). In the fore used in the sense of borrowing , where different event of an interim price decline, the short seller will notes or coins can be returned to the lender (as op- profit, since the cost of (re)purchase will be less than the posed to borrowing a car, where the same car must be proceedswhichch wewerere receiviveded uponthetheiniinitial(short)rt) salsale.e. returned). Conversely, the short position will be closed out at a loss in the event that the price of a shorted instrument should A short seller typically borrows through a , who rise prior to repurchase. The potential loss on a short sale is usually holding the securities for another who is theoretically unlimited in the event of an unlimited rise owns the securities; the broker himself seldom purchases in the price of the instrument, however, in practice, the ththee securiurititieses toto lelendnd toto ththee shshortort sesellller.er.[1] ThThee lelendnderer doess short seller will be required to post or collateral notloslosee ththee ririghghtt toto sesellll ththee securiurititieses whwhililee ththeyeyhahavevebeenn to cover losses, and any inability to do so on a timely ba- lent, as the broker will usually hold a large pool of such sis would cause its broker or counterparty to liquidate the securiurititieses fforor aa numberofof ininvevestostorsrs whichch, asas susuchch securiuri-- position. In the securities markets, the seller generallylly ties are fungible, can instead be transferred to any buyer. must borrow the securities in to effect delivery in In most market conditions there is a ready supply of se- the short sale. In some cases, the short seller must pay a curities to be borrowed, held by pension funds, mutual fee to borrow the securities and must additionally reim- funds and other investors. burse the lender for cash returns the lender would have The act of buying back the securities that were sold short received had the securities not been loaned out. is called “covering the short” or “covering the position”. Short selling is most commonly done with instruments A short position can be covered at any time before the traded in public securities, futures or currency markets,, secsecurities are due to be returned. Once the positiotion is due to the liqliquidity and real-time price disseminatiationon covered, the short seller will not be affected by any sub- characteristic of such markets and because the instru- sequent rises or falls in the price of the securities, as he ments defined within each class are fungible.. already holds the securities required to repay the lender. In In practictical terms, goigoing short can be considsidered the Short selling refers broadly to any transaction used by opposite of the conventional practice of "going long",", an investor to profit from the decline in price of a bor- whereby an investor profits from an increase in the price rowed or financial instrument. However some short of the asset. Mathematically, the return from a short po- positiotions, fofor exexample those undertaken by means ofof sitsitionion isis equivivalealentnt to thathatt ofof owningng (being “long”)g”) a neg- derivatives contracts, are not technically short sales be-

11 2 2 HISTORY cause no underlying asset is actually delivered upon the 3. Short seller is required to return the shares, and is initiation of the position. Derivatives contracts include compelled to buy 100 shares of ACME Inc. for futures, options, and swaps.[2][3] $2,500.

4. Short seller returns the shares to the lender who ac- 1.1 Worked examples cepts the return of the same number of sharesas was lent. 1.1.1 Profitable trade 5. Short seller incurs as a loss the $1,500 difference Shares in ACME Inc. currently trade at $10 per . between the price at which he soldthe shares he bor- rowed and the higher price at which he had to pur- chase the shares he returned (plus borrowing fees). 1. A short seller investor borrows from a lender 100 shares of ACME Inc. and immediately sells them for a total of $1,000. 2 History 2. Subsequently, the price of the shares falls to $8 per share. Some hold that the practice was invented in 1609 by 3. Short seller now buys 100 shares of ACME Inc. for Dutch merchant , a sizeable [4] $800. of the Vereenigde Oostindische Compagnie (VOC). Edward Stringham has written extensively on the de- 4. Short seller returns the shares to the lender, who velopment of sophisticated contracts on the Amsterdam must accept the return of the same number of shares Exchange in the seventeenth century, including as was lent despite the fact that the market value of short sale contracts.[5] Short selling can exert downward the shares has decreased. pressure on the underlying stock, driving down the price of shares of that security. This, combined with the seem- 5. Short seller retains as profit the $200 difference (mi- ingly complex and hard-to-follow tactics of the practice, nus borrowing fees) between the price at which he has made short selling a historical target for criticism. [6] sold the shares he borrowed and the lower price at At various times in history, governments have restricted which he was able to purchase the shares he re- or banned short selling. turned. The London banking house of Neal, James, Fordyce and Down collapsed in June 1772, precipitating a major crisis 1.1.2 Profitable covered trade which included the collapse of almost every private bank in Scotland, and a liquidity crisis in the two major bank- Shares in ACME Inc. currently trade at $10 per share. ing centres of the world, London and Amsterdam. The bank had been speculating by shorting East India Com- 1. A short seller investor owns 100 shares of ACME pany stock on a massive scale, and apparently using cus- Inc. and sells them for a total of $1,000. tomer deposits to cover losses. It was perceived as having a magnifying effect in the violent downturn in the Dutch 2. Subsequently, the price of the shares falls to $8 per tulip market in the eighteenth century. In another well- share. referenced example, became notorious for “breaking the " on of 3. Short seller now buys 100 shares of ACME Inc. 1992, when he sold short more than $10 billion worth of for $800, or alternatively, purchases 125 shares for pounds sterling. $1,000. The term “short” was in use from at least the mid- 4. Short seller retains as profit the $200 difference be- nineteenth century. It is commonly understood that tween the price at which he sold the shares he owned “short” is used because the short-seller is in a deficit posi- and the lower price at which he was able to repur- tion with his brokerage house. was known as chase the shares. The Great Bear of Wall Street who began shorting in the United States in 1822.[7] 1.1.3 Loss-making trade Short sellers were blamed for the Wall Street Crash of 1929.[8] Regulations governing short selling were imple- Shares in ACME Inc. currently trade at $10 per share. mented in the United States in 1929 and in 1940. Po- litical fallout from the 1929 crash led Congress to en- 1. A shortseller borrows 100shares of ACME Inc. and act a law banning short sellers from selling shares dur- immediately sells them for a total of $1,000. ing a downtick; this was known as the , and this was in effect until 3 July 2007 when it was removed 2. Subsequently the price of the shares rises to $25. by the Securities and Exchange Commission (SEC Re- 3.1 Shorting stock in the U.S. 3 lease No. 34-55970).[9] President con- Short selling stock consists of the following: demned short sellers and even J. Edgar Hoover said he would investigate short sellers for their role in prolong- • The speculator instructs the broker to sell the shares ing the Depression. A few years later, in 1949, Alfred andtheproceedsarecreditedto hisbroker’s account Winslow Jones founded a fund (that was unregulated) at the firm upon which the firm can earn . that bought stocks while selling other stocks short, hence Generally, the short seller does not earn interest on hedging some of the market , and the was the short proceeds and cannot use or encumber the born.[10] proceeds for another transaction.[17] Negative news, such as litigation against a company, may also entice professional traders to sell the stock short in • Upon completion of the sale, the investor has 3 days hope of the stock price going down. (in the US) to borrow the shares. If required by law, During the Dot-com bubble, shorting a start-up company the investor first ensures that cash or is on could backfire since itcould be taken overata pricehigher deposit with his brokerage firm as collateral for the than the price at which speculators shorted. Short-sellers initial short margin requirement. Some short sell- were forced to cover their positions at acquisition , ers, mainly firms and hedge funds, participate in the while in many cases the firm often overpaid for the start- practice of , where the shorted up. shares are not borrowed or delivered.

• The speculator may close the position by buying back the shares (called covering). If the price has 2.1 Naked short selling restrictions dropped, he makes a profit. If the stock advanced, he takes a loss. During the 2008 financial crisis, critics argued that in- vestors taking large short positions in struggling financial • Finally, the speculator may return the shares to the firms like , HBOS and Morgan Stan- lender or stay short indefinitely. ley created instability in the and placed ad- ditional downward pressure on prices. In response, a • At any time, the lender may call for the return of number of countries introduced restrictive regulations on his shares e.g. because he wants to sell them. The short-selling in 2008 and 2009. Naked short selling is borrower must buy shares on the market and return the practice of short-selling a tradable asset without first them to the lender (or he must borrow the shares borrowing the security or ensuring that the security can from elsewhere). When the broker completes this be borrowed – it was this practice that was commonly transaction automatically, it is called a 'buy-in'. restricted.[11][12] Investors argued that it was the weak- ness of financial institutions, not short-selling, that drove stocks to fall.[13] In September 2008, the Securities Ex- 3.1 Shorting stock in the U.S. change Commission in the United States abruptly banned short sales, primarily in financial stocks, to protect com- In the U.S., in order to sell stocks short, the sellermustar- panies under siege in the stock market. That ban expired range for a broker-dealer to confirm that it is ableto make several weeks later as regulators determined the ban was delivery of the shorted securities. This is referred to as a not stabilizing the price of stocks.[13][12] locate. have a variety of means to borrow stocks Temporary short-selling bans were also introduced in the in order to facilitate locates and make good delivery of , , , and other Eu- the shorted security. ropean countries in 2008 to minimal effect.[14] Australia The vast majority of stocks borrowed by U.S. brokers moved to ban naked short selling entirely in September come from made by the leading custody and 2008.[11] Germany placed a ban on naked short selling of fund management companies (see list below). Institu- certaineurozonesecuritiesin 2010.[15] Spain andItalyin- tions often lend out their shares in order to earn a little ex- troduced short selling bans in 2011 and again in 2012.[16] tra money on their . These institutional loans Worldwide, economic regulators seem inclined to restrict are usually arranged by the custodian who holds the secu- short selling to decrease potential downward price cas- rities for the institution. In an institutional stock , the cades. Investors continue to argue this only contributes borrower puts up cash collateral, typically 102% of the to market inefficiency.[11] value of the stock. The cash collateral is then invested by the lender, who often rebates part of the interest to the borrower. The interest that is kept by the lender is the 3 Mechanism compensation to the lender for the stock loan. Brokerage firms can also borrow stocks fromthe accounts See also: of their own customers. Typical margin account agree- ments give brokerage firms the right to borrow customer 4 3 MECHANISM shares without notifying the customer. In general, bro- 3.3 Sources of short interest data kerage accounts are only allowed to lend shares from ac- counts for which customers have “debit balances”, mean- Time delayed short interest data (for legally shorted ing they have borrowed from the account. SEC Rule shares) is available in a number of countries, including 15c3-3 imposes such severe restrictions on the lending of the US, the UK, Hong Kong, and Spain. The number of shares from cash accounts or excess margin (fully paid stocks being shorted on a global basis has increased in re- for) shares from margin accounts that most brokerage cent years for various structural reasons (e.g. the growth firms do not bother except in rare circumstances. (These of 130/30 type strategies, shortor bear ETFs). The data is restrictions include that the broker must have the express typically delayed; for example, the requires its permission of the customer and provide collateral or a broker-dealer member firms to report data on the 15th of letter of .) each month, and then publishes a compilation eight days [18] Most brokers will allow customers to borrow shares later. to short a stock only if one of their own customers has Some market data providers (like Data Explorers and purchased the stock on margin. Brokers will go through SunGard Financial Systems[19]) believe that stock lend- the “locate” process outside their own firm to obtain bor- ing data provides a good proxy for short interest levels rowed shares from other brokers only for their large insti- (excluding any naked short interest). SunGard provides tutional customers. dailydata on short interest by trackingtheproxyvariables [20] Stock exchanges such as the NYSE or the NASDAQ typ- based on borrowing and lending data which it collects. ically report the “short interest” of a stock, which gives the number of shares that have been legally sold short as a percent of the total float. Alternatively, these can 3.4 Short selling terms also be expressed as the short interest ratio, which is the number of shares legally sold short as a multiple of the Days to Cover (DTC) is a numerical term that describes average daily volume. These can be useful tools to spot the relationship between the number of shares in a given trends in stock price movements but in order to be reli- equity that has been legally short-sold and the number of able, investors must also ascertain the number of shares days of typical trading that it would require to 'cover' all brought into existence by naked shorters. Speculators are legal short positions outstanding. For example, if there cautioned to remember that for every share that has been are ten million shares of XYZ Inc. that are currently shorted (owned by a new owner), a 'shadow owner' exists legally short-sold and the average daily volume of XYZ (i.e. the original owner) who also is part of the universe shares traded each day is one million, it would require ten of owners of that stock, i.e. Despite not having any vot- days of trading for all legal short positions to be covered ing rights, he has not relinquished his interest and some (10 million / 1 million). rights in that stock. Short Interest is a numerical term that relates the num- ber of shares in a given equity that have been legally shorted divided by the total for the company, usually expressed as a percent. For example, if there areten million shares of XYZ Inc. that arecurrently 3.2 Securities lending legally shortsold, andthe total number of shares issuedby the company is one hundred million, the Short Interest is 10%(10million / 100million). If however, shares arebe- Main article: Securities lending ing created through naked short selling, “fails” data must be accessed to assess accurately the true level of short in- terest. When a security is sold, the seller is contractually obliged to deliver it to the buyer. If a seller sells a security short Borrow cost is the fee paid to a securities lender for bor- without owning it first, the seller needs to borrow the se- rowing the stock or other security. The cost of borrowing curity from a third party to fulfill its obligation. Other- the stock is usually negligible compared to fees paid and wise, the seller will “fail to deliver,” the transaction will interest accrued on the margin account - in 2002, 91% of not settle, and the seller may be subject to a claim from stocks could be shorted for less than a 1% fee per annum, its counterparty. Certain large holders of securities, such generally lower than interest rates earned on the margin as a custodian or management firm, oftenlend account. However, certain stocks become “hard to bor- outthesesecurities to gain extraincome, a process known row” as stockholders willing to lend their stock become as securities lending. The lender receives a fee for this more difficult to locate. The cost of borrowing these service. Similarly, retail investors can sometimes make stocks canbecome significant- in February 2001, thecost an extra fee when their broker wants to borrow their se- to borrow (short) stock reached an annual- curities. This is only possible when the investor has full ized 55%, indicating that a short seller would need to pay title of the security, so it cannot be used as collateral for the lender more than half the price of the stock over the margin buying. course of the year, essentially as interest for borrowing 5 a stock in limited supply.[21] This has important implica- stringent were put in place in September 2008, ostensi- tions for derivatives pricing and strategy, as the borrow bly to prevent the practice from exacerbating market de- cost itself can become a significant convenience for clines. The rules were made permanent in 2009. holding the stock (similar to additional ) - for in- stance, put-call parity relationships are broken and the early feature of American call options on non- 4 Fees dividend paying stocks can become rational to exercise early, which otherwise would not be economical.[22] When a broker facilitates the delivery of a client’s short sale, the client is charged a fee for this service, usually a 3.4.1 Major lenders standard commission similar to that of purchasing a sim- ilar security. • State Street (Boston, United States) If the short position begins to move against the holder of the short position (i.e., the price of the security begins to • Lynch (New Jersey, United States) rise), money will be removed from the holder’s cash bal-

• JP Morgan Chase (New York, United States) ance and moved to his or her margin balance. If short shares continue to rise in price, and the holder does not • (Chicago, United States) have sufficient funds in the cash account to cover the po- sition, the holder will begin to borrow on margin for this • (Amsterdam, , now defunct) purpose, thereby accruing margin interest charges. These are computed and charged just as for any other margin • ABN AMRO (Amsterdam, Netherlands, formerly Fortis) debit. Therefore, only margin accounts can be used to open a short position. • (New York, United States) When a security’s ex-dividend date passes, the dividend is deductedfromthe shortholder’s account andpaid to the • Bank of New York Mellon Corporation (New York, United States) person from whom the stock is borrowed. For some brokers, the shortseller may notearn interest on • UBS AG (Zurich, ) the proceeds of the short sale or use it to reduce outstand- ing margin debt. These brokers may not pass this benefit • (London, United Kingdom) on to the retail client unless the client is very large. The interest is often split with the lender of the security. 3.5 Naked short selling

Main article: Naked short selling 5 and voting rights

A naked short sale occurs when a security is sold short Where shares have been shorted and the company which without borrowing the security within a set time (for ex- issues thesharesdistributesa dividend, thequestion arises ample, three daysin the US.) This means thatthe buyer of as to who receives the dividend. The new buyer of the such a short is buying the short-seller’s promise to deliver shares, who is the “holder of record” and holds the shares a share, rather than buying the share itself. The short- outright, will receive the dividend from the company. seller’s promise is known as a hypothecated share. However, the lender, who may hold its shares in a margin account with a prime broker and is unlikely to be aware When the holder of the underlying stock receives a divi- that these particular shares are being lent out for short- dend, the holder of the hypothecated share would receive ing, also expects to receive a dividend. The short seller an equal dividend from the short seller. will therefore pay to the lender an amount equal to the Naked shorting has been made illegal except where al- dividend in order to compensate, though as this payment lowed under limited circumstances by market makers. It does not come from the company it is not technically a is detected by the Depository Trust & Clearing Corpora- dividend as such. The short seller is therefore said to be tion (in the US) as a “failure to deliver” or simply “fail.” “short the dividend”. While many fails are settled in a short time, some have A similar issue comes up with the voting rights attached to been allowed to linger in the system. the shorted shares. Unlike a dividend, voting rights can- In the US, arranging to borrow a security before a short not legally be synthesized and so the buyer of the shorted sale is called a locate. In 2005, to prevent widespread share, as the holder of record, controls the voting rights. failure to deliver securities, the U.S. Securities and Ex- The owner of a margin account from which the shares change Commission (SEC) put in place Regulation SHO, were lent will have agreed in advance to relinquish vot- intended to prevent speculators from selling some stocks ing rights to shares during the period of any short sale.[23] short before doing a locate. Requirements that are more As noted earlier, victims of Naked Shorting sometimes 6 7 report that the number of votes cast is greater than the futures or options; the preceding method is used to bet on number of shares issued by the company.[24] the spot price, which is more directly analogous to selling a stock short.

6 Markets 7 Risks 6.1 Futures and options contracts

When trading futures contracts, being 'short' means hav- Note: this section does notapply to currency markets. ing the legal obligation to deliver something at the ex- Short selling is sometimes referred to as a “negative in- piration of the contract, although the holder of the short come investment strategy” because there is no potential position may alternately buy back the contract prior to ex- for dividend income or interest income. Stock is held piration instead of making delivery. Short futures trans- only long enough to be sold pursuant to the contract, actions are often used by producers of a commodity to and one’s return is therefore limited to short term capital fix the future price of goods they have not yet produced. gains, which are taxed as ordinary income. For this rea- Shorting a is sometimes also used by son, buying shares (called “going long”) has a very differ- those holding the underlying asset (i.e. those with a long ent risk profile from selling short. Furthermore, a “long’s” position) as a temporary hedge against price declines. losses are limited because the price can only go down to Shorting futures may also be used for speculative trades, zero, but gains are not, as there is no limit, in theory, on in which case the investor is looking to profit from any how high the price can go. On the other hand, the short decline in the price of the futures contract prior to expi- seller’s possible gains are limited to the original price of ration. the stock, which can only go down to zero, whereas the An investor can also purchase a put , giving that loss potential, again in theory, has no limit. For this rea- investor the right (but not the obligation) to sell the un- son, short selling probably is most often used as a hedge derlying asset (such as shares of stock) at a fixed price. In strategy to manage the risks of long investments. the event of a market decline, the option holder may ex- Many short sellers place a "stop order" with their stock- ercise these put options, obliging the counterparty to buy broker after selling a stock short. This is an order to the the underlyingasset at the agreed upon (or “strike”) price, brokerage to cover the position if the price of the stock which would then be higher than the current quoted spot should rise to a certain level, in order to limit the loss and price of the asset. avoid the problem of unlimited liability described above. In some cases, if the stock’s price skyrockets, the stock- broker may decide to cover the short seller’s position im- 6.2 Currency mediately and without his consent, in order to guarantee that the short seller will be able to make good on his debt Selling short on the currency markets is different from of shares. selling short on the stock markets. Currencies are traded in pairs, each currency being priced in terms of another. Short sellers must be aware of the potential for a short In this way, selling short on the currency markets is iden- squeeze. When the price of a stock rises significantly, tical to going long on stocks. some people who are shorting the stock will cover their positions to limit their losses (this may occur in an auto- Novice traders or stock traders can be confused by the mated way if theshortsellershad stop-loss ordersin place failure to recognize and understand this point: a contract with their brokers); others may be forced to close their is always long in terms of one medium and short another. position to meet a margin call; others may be forced to When the exchange rate has changed, the trader buys the cover, subject to the termsunder which theyborrowed the first currency again; this time he gets more of it, and pays stock, if the person who lent the stock wishes to sell and back the loan. Since he got more money than he had bor- take a profit. Since covering their positions involves buy- rowed initially, he makes money. Of course, the reverse ing shares, the causes an ever further rise can also occur. in the stock’s price, which in turn may trigger additional covering. Because of this, most short sellers restrict their An example of this is as follows: Let us say a trader wants activities to heavily traded stocks, and they keep an eye to trade with the US dollar and the curren- on the “short interest” levels of their short investments. cies. Assume that the current market rate is USD 1 to Short interest is defined as the total number of shares that Rs.50 and the trader borrows Rs.100. With this, he buys have been legally sold short, but not covered. A short USD 2. If the next day, the conversion rate becomes squeeze can be deliberately induced. This can happen USD 1 to Rs.51, then the trader sells his USD 2 and gets when large investors (such as companies or wealthy indi- Rs.102. He returns Rs.100 and keeps the Rs.2 profit (mi- viduals) notice significant short positions, and buy many nus fees). shares, with the intent of selling the position at a profit to One may also take a short position in a currency using the short sellers who will be panicked by the initial uptick 8.2 7 or who are forced to cover their short positions in order can create substantial positions. The largest to avoid margin calls. risk is that interest rates overall move. The trader can hedge this risk by selling government bonds Another risk is that a given stock may become “hard to short against his long positions in corporate bonds. borrow.” As defined by the SEC and based on lack of In this way, the risk that remains is of the availability, a broker may charge a hard to borrow fee corporate bonds. daily, without notice, for any day that the SEC declares a share is hard to borrow. Additionally, a broker may be requiredto cover a shortseller’s position at any time (“buy • An options trader may short shares in order to re- in”). The short seller receives a warning from the broker main so that he is not exposed to risk that he is “failing to deliver” stock, which will lead to the from price movements in the stocks that underlie his buy-in.[25] options Because short sellers must deliver the shorted securities to their broker eventually, and will need money to buy them, there is a credit risk for the broker. The penalties 8.2 Arbitrage for failure to deliver on a short selling contract inspired financier Daniel Drew to warn: “He who sells what isn't Further information: Arbitrage his’n, Must buy it back or go to pris’n.” To manage its own risk, the broker requires the short seller to keep a margin account, and charges interest of between 2% and A short seller may be trying to benefit from market inef- 8% depending on the amounts involved.[26] ficiencies arising from the mispricing of certain products. Examples of this are In 2011, the eruption of the massive China stock frauds on North American equity markets brought a related risk to light for the short seller. The efforts of research- • An arbitrageur who buys long futures contracts on a oriented short sellers to expose these frauds eventually US Treasury security, and sells short the underlying prompted NASDAQ, NYSE and other exchanges to im- US Treasury security. pose sudden, lengthy trading halts that froze the values of shorted stocks at artificially high values. Reportedly in some instances, brokers charged short sellers excessively large amounts of interest based on these high values as the 8.3 Against the box shorts were forced to continue their borrowings at least until the halts were lifted.[27] One variant of selling short involves a long position. “Selling short against the box” consists of holding a long Short sellers tend to temper overvaluation by selling into position on which the shares have already risen, where- exuberance. Likewise, short sellers are said to provide upon onethenenters a shortsellorder for an equalamount price support by buying when negative sentiment is ex- of shares. The term box alludes to the days when a safe acerbated after a significant price decline. Short selling deposit box was used to store (long) shares. The purpose can have negative implications if it causes a premature or of this technique is to lock in paper profits on the long unjustified share price collapse when the fear of cancel- position without having to sell that position (and possi- lation due to bankruptcy becomes contagious.[28] bly incur if said position has appreciated). Once the short position has been entered, it serves to balance the long position taken earlier. Thus, from that point in 8 Strategies time, the profit is locked in (less brokerage fees and short financing costs), regardless of further fluctuations in the 8.1 Hedging underlying share price. For example, one can ensure a profit in this way, while delaying sale until the subsequent Further information: Hedge (finance) year. U.S. investors considering entering into a “short against Hedging often represents a means of minimizing the risk the box” transaction should be aware of the tax conse- from a more complex set of transactions. Examples of quences of this transaction. Unless certain conditions are this are: met, the IRS deems a “short against the box” position to be a “constructive sale” of the long position, which is a taxable event. These conditions include a requirement • A farmer who has just planted his wheat wants to lock in the price at which he can sell after the har- that the short position be closed out within 30 days of the vest. He would take a shortposition in wheat futures. end of the year and that the investor must hold their long position, without entering into any hedging strategies, for • A in corporate bonds is constantly a minimum of 60 days after the short position has been trading bonds when clients want to buy or sell. This closed.[29] 8 11 SEE ALSO

9 Regulations banned short selling,[38] and later placed an indefinite ban on naked short selling.[39] Australia’s ban on short sell- ing was further extended for another 28 days on 21 Oc- 9.1 United States tober 2008.[40] Also during September 2008, Germany, Ireland, Switzerland and Canada banned short selling The Securities and Exchange Act of 1934 gave the leading financial stocks,[41] and France, the Netherlands Securities and Exchange Commission the power to reg- and banned naked short selling leading financial ulate short sales.[30] The first official restriction on short stocks.[42] By contrast with the approach taken by other selling came in 1938, when the SECadopteda rule known countries, Chinese regulators responded byallowingshort as the uptick rule that dictated that a short sale could only selling, along with a package of other market reforms.[43] be made when the price of a particular stock was higher than the previous trade price. The uptick rule aimed to prevent short sales from causing or exacerbating market price declines.[31] In January 2005, The Securities and 10 Views of short selling Exchange Commission enacted Regulation SHO to tar- get abusive naked short selling. Regulation SHO was the Advocates of short selling argue that the practice is an es- SEC’s first update to short selling restrictions since the sential part of the mechanism.[44] Finan- [32][33] uptick rule in 1938. cial researchers at Duke University said in a study that The regulation contains two key components: the “lo- short interest is an indicator of poor future stock perfor- cate”and the “close-out.” The locatecomponent attempts mance (the self-fulfilling aspect) and that short sellers ex- [45] to reduce failure to deliver securities by requiring a bro- ploit market mistakes about firms’ fundamentals. ker possess or have arranged to possess borrowed shares. Such noted investors as and Warren Buf- The close out component requires that a broker be able fett have said that short sellers help the market. Klarman [31][34] to deliver the shares that are to be shorted. In the argued that short sellers are a useful counterweight to the US, initial public offers (IPOs) cannot be sold short for widespread bullishness on Wall Street,[46] while Buffett a month after they start trading. This mechanism is in believes that short sellers are useful in uncovering fraud- place to ensure a degree of price stability during a com- ulent and other problems at companies.[47] pany’s initial trading period. However, some brokerage firms that specialize in penny stocks (referred to collo- Shortseller James Chanos received widespread publicity quially as bucket shops) have used the lack of short sell- when he was an early critic of the accounting practices [48] ing during this month to thinly traded of . Chanos responds to critics of short-selling IPOs. Canada and other countries do allow selling IPOs by pointing to the critical role they played in identifying (including U.S. IPOs) short.[35] problems at Enron, Boston Market and other “financial disasters” over the years.[49] In 2011, research oriented The Securities and Exchange Commission initiated a short sellers were widely acknowledged for exposing the temporary ban on short selling on 799 financial stocks China stock frauds.[50] from 19 September 2008 until 2 October 2008. Greater penalties for naked shorting, by mandating delivery of Commentator has expressed concern about stocks at clearing time, were also introduced. Some state short selling and started a petition calling for the rein- [51] governors have beenurging state pensionbodies to refrain troduction of the uptick rule. Books like Don't Blame from lending stock for shorting purposes.[36] An assess- the Shorts by Robert Sloan and Fubarnomics by Robert ment of the effect of the temporary ban on short-selling E. Wright suggest Cramer exaggerated the costs of short in the United States and other countries in the wake of selling and underestimated the benefits, which may in- the financial crisis showed that it had only “little impact” clude the ex ante identification of asset bubbles. on the movements of stocks, with stock prices moving in Individual short sellers have been subject to criticism and the same way as they would have moved anyhow, but the even litigation. Manuel P. Asensio, for example, engaged ban reduced volume and liquidity.[14] in a lengthylegal battle with thepharmaceutical manufac- turer Hemispherx Biopharma.[52] Several studies of the effectiveness of short selling bans 9.2 Europe, Australia and China indicate that short selling bans do not contribute to more moderate market dynamics.[53][54][55][56] In the UK, the Financial Services Authority had a mora- torium on short selling 29 leading financial stocks, ef- fective from 2300 GMT, 19 September 2008 until 16 January 2009.[37] After the ban was lifted, John McFall, 11 See also chairman of the Treasury Select Committee, House of Commons, made clear in public statements and a letter • Inverse exchange-traded fund to the FSA that he believed it ought to be extended. Be- tween 19 and 21 September 2008, Australia temporarily • 9

• [14] Oakley, David (18 December 2008). “Short-selling ban has minimal effect”. Financial Times . Retrieved 12 • Socially responsible investing September 2012.

• [15] Crawford, Alan (18 May 2010). “Germany to Temporar- ily BanNaked Short Selling,Some Swapsof Euro Bonds”. • Manuel P. Asensio Bloomberg. Retrieved 13 September 2012.

• James Chanos [16] Tracy Rucinski and Stephen Jewkes (23 July 2012). “Spain, Italy reinstate short-selling ban”. . Re- • trieved 12 September 2012.

• Joseph Parnes [17] Federal Reserve Board. Regulation T § 220.12

• Margin [18] NASDAQ. About the Short Interest Page.

[19] SunGard’s ShortSide.com discusses the product.

12 Notes [20] SunGard. SunGard Launches BorrowIndices; First Proxy for Measuring Short Interest on a Daily Basis. Business [1] “Understanding Short Selling - A Primer”. Langas- Wire. set.com. Retrieved 24 May 2012. [21] “The market for borrowing stock” (PDF). Retrieved 25 [2] Larry Harris(2002). “TradingandExchange: Market Mi- December 2012. crostructure for Practitioners”. Oxford University Press. p. 41. ISBN 0195144708. [22] “Lecture 13: Hard to Borrow Securities” (PDF). Re- trieved 25 December 2012. [3] Don M. Chance and Robert Brooks. “An Introduction to Derivatives and Risk Management”. South-Western Col- [23] “What happens to the voting rights on shares when the lege. p. 6. ISBN 0324601204. shares are used in a short sale transaction?" . Investopedia. Retrieved 4 December 2008. [4] NRC Handelsblad - Naked short selling is an old-Dutch trick (in Dutch only) Archived 31 May 2013 at the [24] Greg LandContactAll Articles (15 May 2009). “Over- Wayback Machine voting at Taser in 2005”. Law.com. Retrieved 24 May 2012. [5] Stringham, Edward (2003). “The Extralegal Develop- ment of Securities Trading in Seventeenth Century Ams- [25] Arnold, Roger (14 January 2000). “Knowing the Rules of terdam”. Quarterly Review of Economics and Finance 43 the Shorting Game”. TheStreet. Retrieved 24 May 2012. (2): 321. Retrieved 12 January 2015. [26] “margin account rates schedule”. ScotTrade. 18 June [6] “Moritz College of Law” (PDF). osu.edu. 2011. [7] “Scripophily - PSTA - Professional Scripophily Trade As- [27] “Even Short-Sellers Burned by Chinese Shares”. Barrons . sociation”. Encyberpedia.com. Retrieved 24 May 2012. 18 June 2011. [8] “Short sellershave beenthe villain for 400 years”. Reuters . [28] “The Theory and Practice of Short Selling, Chapter 9, 26 September 2008. Retrieved 28 September 2008. Conclusions and Implications for Investors by Frank J. [9] “SEC Release No. 34-55970” (PDF). Retrieved 24 May Fabozzi, Editor”. Books.google.com. Retrieved 24 May 2012. 2012.

[10] Lindgren, Hugo (9 April 2007). “New York Magazine [29] “United States IRS Publication 550 Investment Income - The Creation of the Hedge Fund” . Nymag.com. Re- and Expenses”. Irs.gov. Retrieved 24 May 2012. trieved 24 May 2012. [30] “Securities Exchange Act of 1934” (PDF). Securities and [11] Lavinio, Stefano (1999). “The Hedge Fund Handbook: Exchange Commission. 1934. A Definitive Guide for Analyzing and Evaluating Alter- native Investments”. McGraw-Hill. pp. 442–443. ISBN [31] Lavinio, Stefano (1999). “The Hedge Fund Handbook: 0071350306. A Definitive Guide for Analyzing and Evaluating Alter- native Investments”. McGraw-Hill. pp. 85–95. ISBN [12] Madura, Jeff (2009). “Financial Markets and Institu- 0071350306. tions”. South-Western College Publishing. p. 308. ISBN 1439038848. [32] S.K. Singh (2009). “Bank Regulations”. Discovery Pub- lishing House. pp. 122–123. ISBN 818356447X. [13] Harris, Larry (7 October 2008). “A Debate as a Ban on Short-Selling Ends: Did It Make Any Difference?". The [33] U.S. SEC (11 April 2005). “Division of Market Regula- New York Times . Retrieved 12 September 2012. tion: Key Points about Regulation SHO”. 10 14 EXTERNAL LINKS

[34] Young, Matthew G. (2010). “The Complete Guide to [54] Lobanova O, Hamid S. S. and Prakash A. J. (2010) “The Selling Stocks Short: Everything You Need to Know Ex- impactof short-sale restrictions onvolatility,liquidity,and plained Simply”. Atlantic Publishing Group Inc. pp. market efficiency: the evidence from the short-sale ban in 178–179. ISBN 1601383266. the u.s.” Technicalreport, FloridaInternational University - Department of Finance. [35] Mahipal Singh (2011). “Security Analysis with Invest- ment and Portfolio Management”. Gyan Books. p. 233. [55] Beber A. and Pagano M. (2009) “Short-selling bans ISBN 8182055199. around the world: Evidence from the 2007-09 crisis”. CSEF Working Papers 241, Centre for Studies in Eco- [36] Tsang, Michael (19 September 2008). “Short Sellers un- nomics and Finance (CSEF), University of Naples, Italy. der Fire in U.S., U.K. After AIG Fall” . bloomberg.com. [56] Kerbl S (2010) “Regulatory Medicine Against Finan- [37] BBC (18 September 2008). “FSA clamps down on short- cial Market Instability: What Helps And What Hurts?" selling”. BBC News . Retrieved 4 January 2010. arXiv.org. [38] “The Australian”. 2 October 2008.

[39] “ASX ban on short selling is indefinite”. The Sydney Morning Herald . 3 October 2008. 13 References

[40] “Australian Securities and Investments Commission - • Sloan, Robert. Don't Blame the Shorts: Why 08-210 ASIC extends ban on covered short selling”. Short Sellers Are Always Blamed for Market Crashes Asic.gov.au. Retrieved 24 May 2012. and Why History Is Repeating Itself , (New York: [41] McDonald, Sarah (22 September 2008). “Australian short McGraw-Hill Professional, 2009). ISBN 978-0-07- selling ban goes further than other bourses”. National 163686-5 Business Review. Retrieved 9 November 2011. • Wright, Robert E. Fubarnomics: A Lighthearted, [42] Ram, Vidya (22 September 2008). “Europe Spooked By Serious Look at America’s Economic Ills , (Buffalo, Revenge Of The Commodities”. Forbes . N.Y.: Prometheus, 2010). ISBN 978-1-61614-191- [43] Shen, Samuel (5 October 2008). “UPDATE 2-China to 2 launch stocks margin trade, short sales”. Reuters . • Fleckner, Andreas M. 'Regulating Trading Prac- [44] “Short Sale Constraints And Stock Returns by C.M Jones tices' in The Oxford Handbook of Financial Regula- and O.A. Lamont”. Papers.ssrn.com. 20 September tion (Oxford: Oxford UniversityPress, 2015). ISBN 2001. doi:10.2139/ssrn.281514. Retrieved 24 May 2012. 978-0-19-968720-6 [45] “Do Short Sellers Convey Information About Changes in Fundamentals or Risk?" (PDF). Retrieved 24 May 2012. 14 External links [46] Margin of safety (1991), by Seth Klarman. ISBN 0- 88730-510-5 • Porsche VW Shortselling Scandal [47] Casterline, Rick (1 June 2006). “2006 Berkshire Hathaway Annual Meeting Q&A with Warren Buffett”. • “Short-Selling Bans Dampen 130/30 Strategies Fool.com. Retrieved 24 May 2012. Worldwide,” Global Investment Technology, Sept. 29, 2008 [48] Peterson, Jim (6 July 2002). “Balance Sheet : The silly

season isn't over yet”. The New York Times . Archived • Short Selling Introduction from the original on 31 May 2013. Retrieved 9 August 2009. • Short Interest: What it tells us

[49] Contrarian Investor Sees Economic Crash in China • SEC Discussion of Naked Short Selling [50] Alpert, Bill (18 June 2011). “B. Alpert “Even Short Sell- ersBurned by ChineseShares”(Barrons20110618)". On- line.barrons.com. Retrieved 24 May 2012.

[51] “TheStreet”. TheStreet. Retrieved 24 May 2012.

[52] Nelson, Brett (26 November 2001). “Short Story”. Forbes . Retrieved 9 August 2009.

[53] Marsh I and Niemer N (2008) “The impact of short sales restrictions”. Technical report, commissioned and funded by the International Securities Lending Associa- tion (ISLA) the Alternative As- sociation (AIMA) and London Asso- ciation (LIBA). 11

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