1.3.5 - Selling Short

What does selling short involve?

Selling borrowed securities with the intention of buying them back later at a lower price.

How does a short seller make a profit?

By selling high first and buying back lower later.

What are the 4 basic steps of a short sale?

1. Borrow the security from the broker-dealer.

2. Sell it in the market.

3. Wait for price to fall.

4. Buy it back and return it.

If an investor sells short at $75 and buys back at $60, what is the profit?

$15 per share.

If an investor sells short at $50 and buys back at $200, what is the result?

$150 loss per share.

Why is short selling considered high risk?

Because potential losses are unlimited. (There is no ceiling on how high a stock price can rise).

What type of investor is a short seller?

A bearish investor. (Expects prices to fall).

In what type of market do short sellers hope to profit?

A bear market.

Define bear market.

A market that generally declines over an extended period.

Define bull market.

A market that generally increases over an extended period.

What type of account is required to sell short?

A margin account.

What is leverage?

Investing with borrowed funds, which amplifies both gains and losses.

Before a short sale can occur, what must the broker-dealer do?

Locate the shares to borrow.

Where do most borrowed shares come from?

Other customers' margin accounts. Lenders. (If they signed a loan consent form).

Does the original owner usually know their shares were lent out?

No.

Who is responsible for paying dividends on shorted shares?

The short seller.

If a stock pays a $1 dividend and 100 shares are sold short, how much must the short seller pay?

$100.

Why might a dividend payment be partially offset for a short seller?

Because the stock price typically drops by the dividend amount on the ex-dividend date.

Who should consider selling short?

Only sophisticated investors with high risk tolerance.

What is the maximum loss on a short sale?

Unlimited.

Exam Trap Questions 🕸

What is the maximum gain on a short sale?

Limited to the amount originally sold for (if the stock goes to $0).

Quick Memory Tricks ⭐

• Short = Sell FIRST, Buy LATER

• Short = Bearish

• Long = Bullish

• Short risk = Unlimited

• Long risk = Limited to what you invested

• Short sellers PAY dividends

• Margin account required