Please explain what a short seller is on the hook for when he or she shorts a stock (i.e. dividends, rights offerings, etc.).

By Investopedia Staff AAA
A:

Short selling is hard enough to get your head around without getting into all the particulars. If you have a basic understanding of short selling, then you probably know that as a short seller, you are required to make up for any benefits a long investor would receive if he or she had actually owned the stock.

When you short a stock, you are borrowing the stock from an investor or broker, then selling those shares on the open market to a second investor. Even though you borrowed and sold the shares to another investor, the transaction between you and the lender is still listed on the books as if the lender is still long on the stock and you are short on the stock (even though that person no longer owns the stock).

Because that original investor who was kind enough to lend you the stock is no longer an actual shareholder with the company, the short seller is required to make up for any benefits the investor would have received had he or she actually still owned the stock.

In other words, if a company pays a dividend to shareholders, the second investor who bought the shares from the short seller would get the dividend check from the company. But because the original investor is no longer a shareholder of record (because the second investor owns those shares now), then the short seller must pay the dividend out of his or her own pocket.

Finally, when the short seller decides to close out the short position, he or she buys shares on the open market (from a third investor) and then gives the shares back to the original investor, who closes out the short position and puts everything back to square one.

For further information on short selling, please see our Short Selling tutorial.

RELATED FAQS

  1. How can you use a debt service coverage ratio (DSCR) to evaluate real estate investments?

    Learn how calculating the debt service coverage ratio for an investment property can help real estate investors evaluate ...
  2. What is the average annual dividend yield of companies in the banking sector?

    Find out the average annual dividend yield for the banking sector and compare it to the broader market. Dividend yield growth ...
  3. What kind of securities should a risk-averse investor buy?

    Understand what risk aversion means in terms of investment, and learn the investment options available to investors who prefer ...
  4. How can I profit from a decline in the drugs sector?

    Learn how to profit from a decline in the drugs sector by short selling drug stocks or by purchasing futures contracts and ...
RELATED TERMS
  1. Dividend

    A distribution of a portion of a company's earnings, decided ...
  2. David Einhorn

    Known for his short selling strategy, activist investor David ...
  3. Short Call

    A type of strategy regarding a call option, which is a contract ...
  4. Long-Short Ratio

    The amount of a security available for short sale compared to ...
  5. S&P 500 Dividend Aristocrats

    Companies that have had an increase in dividends for 25 consecutive ...
  6. Stock Loan Rebate

    Interest paid by a stock lender to a borrower who has put up ...

You May Also Like

Related Articles
  1. Trading Strategies

    Bucking The Trend With Pattern Failure ...

  2. Trading Strategies

    A Guide Of Option Trading Strategies ...

  3. Technical Indicators

    Use Volume And Emotion To Tackle Topping ...

  4. Active Trading Fundamentals

    Where And How To Trade Energy Stocks

  5. Mutual Funds & ETFs

    Should the YYY ETF Be on Your Radar?

Trading Center