What happens when the lender of the borrowed shares in a short sale transaction wants to sell his/her shares?

By Chad Langager AAA
A:

In a short sale transaction, shares are borrowed from the lender by the short seller and sold in the market. The lender of these shares continues to maintain a long position, hoping the shares will go up in value.

If the lender wants to sell the stock, the implications for the short seller will depend on where the shares were borrowed from - generally either from the brokerage firm's inventory or from the margin account of one of the firm's clients. Margin accounts differ from cash accounts in that they allow the firm to use shares held in these accounts in various ways, including lending them for short sales. If the brokerage firm has taken the shares from its client's account, and that client wishes to sell the stock at some point while the short position is being held, the client is able to do so.

This sale by the client who was lending shares will usually have no effect on the short seller, as the firm will either borrow the shares from another firm or use other shares in its own inventory. For example, if Jack has 100 shares that are lent out to the short seller and Jack now wishes to sell the 100 shares, all he has to do is inform his brokerage firm. The firm will then look in its inventory, and if there are 100 shares, the firm will sell them on the market and put the proceeds into Jack's account. The brokerage firm will now be the one that is owed the shares by the short seller, Jill. However, what could hurt Jill is if the brokerage firm decides that it no longer wants to hold its position in the stock and it is unwilling to continue to lend the shares to her. The brokerage firm has the right to call any short seller to return the shares at any point in time. In this case, Jill the short seller will have to return the shares to the brokerage firm by purchasing them on the market, regardless of whether she ends up incurring a loss or a gain.

If you are the one whose shares are being lent out by your broker to a short seller, your part in the short sale transaction will have no effect on your ability to sell the shares. During the short sale, your shares are the ones currently being designated as lent out by the brokerage firm, but the broker essentially owes you shares. When you want to sell the shares, the broker is required to replace your shares so you may sell them on the market. In our current age of electronic-based shares and transactions, all of this is done without your knowledge and has little effect on the average client. (To learn more about short selling and margin trading, see our Short Selling Tutorial and our Margin Trading Tutorial.)

RELATED FAQS

  1. What investors come close to challenging Warren Buffett as the greatest investor ...

    Discover two legendary investors who not only challenge but perhaps exceed Warren Buffett in terms of their talent and achievements ...
  2. If I use hedging as a risk strategy, do I have to keep my eye on my portfolio all ...

    Understand the concept of hedging and learn how this key element to portfolio management can help an investor protect profits ...
  3. What are common trading strategies used in a bull market?

    Discover four commonly used trading strategies by investors and analysts to make profits from a prolonged bull market, including ...
  4. Do you have to be an expert investor to trade put options?

    Learn about investing in put options and the associated risks. Explore how options can provide risk, which is precisely defined ...
RELATED TERMS
  1. David Einhorn

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

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

    The amount of a security available for short sale compared to ...
  4. Stock Loan Rebate

    Interest paid by a stock lender to a borrower who has put up ...
  5. Stock Loan Fee

    A fee charged by a brokerage firm to a client for borrowing shares. ...
  6. Short-Interest Theory

    A theory which holds that a security with a high degree of short ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    Are These the Top Inverse ETFs of 2 ...

  2. Mutual Funds & ETFs

    Will the Natural Gas ETF KOLD Stay Hot?

  3. Options & Futures

    How To Protect A Short Position With ...

  4. Mutual Funds & ETFs

    A Guide to Using Inverse ETFs for Diversification

  5. Trading Strategies

    Book Reliable Profits With Pullback ...

Trading Center