A:

The simple answer to this question is that stock splits do not affect short sellers in a material way. There are some changes that occur as a result of a split that do affect the short position, but they don't affect the value of the short position. The biggest change that happens to the portfolio is the number of shares being shorted and the price per share.

When an investor shorts a stock, he or she is borrowing the shares, and is required to return them at some point in the future. For example, if an investor shorts 100 shares of ABC at $25, he or she will be required to return 100 shares of ABC to the lender at some point in the future. If the stock undergoes a 2:1 split before the shares are returned, it simply means that the number of shares in the market will double along with the number of shares that need to be returned.

When a company splits its shares, the value of the shares also splits. To continue with the example, let's say the shares were trading at $20 at the time of the 2:1 split; after the split, the number of shares doubles and the shares trade at $10 instead of $20. If an investor has 100 shares at $20 for a total of $2,000, after the split he or she will have 200 shares at $10 for a total of $2,000.

In the case of a short investor, he or she initially owes 100 shares to the lender, but after the split he or she will owe 200 shares at a reduced price. If the short investor closes the position right after the split, he or she will buy 200 shares in the market for $10 and return them to the lender. The short investor will have made a profit of $500 (money received at short sale ($25 x 100) less cost of closing out short position ($10 x 200). That is, $2,500 - $2,000 = $500). The entry price for the short was 100 shares at $25, which is equivalent to 200 shares at $12.50. So the short made $2.50 per share on the 200 shares borrowed, or $5 per share on 100 shares if he or she had sold before the split.

Neither a long nor a short position is materially affected by a stock split - the value of the position does not change. So, if a company has announced that it will split in six months, it should have no bearing on the attractiveness of the short investment.

(To learn more about stock splits and short selling, read our Short Selling Tutorial and Understanding Stock Splits.)

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