What is a 'Rebate'
A rebate is the portion of interest or dividends earned by the owner (lender) of securities that are paid to a short seller (borrower) of the securities. The borrower is required to pay the interest or dividends to the owner. Short selling is highly risky, and trades must be made in a margin account to protect the account from losses.
BREAKING DOWN 'Rebate'
Selling short refers to selling securities that the investor does not own, which means that the investor must borrow securities to make delivery to a buyer. When an investor places a short sale trade, that individual must deliver the securities to the buyer on the trade settlement date. The goal of selling short is to profit from a price decline by buying the securities at a lower price after the sale. Selling short exposes the seller to unlimited risk, since the price of the shares that must be purchased can increase by an unlimited amount.
If dividends are paid during the period that the securities are borrowed, the borrower must pay the dividends to the lender. If bonds are sold short, any bond interest paid on the borrowed securities must be forwarded to the lender.
Factoring in a Short Sale Rebate Fee
When a short seller borrows shares to make delivery to the buyer, the seller must pay a rebate fee. This fee depends on the dollar amount of the sale and the availability of the shares in the marketplace. If the shares are difficult or expensive to purchase, the rebate fee will be higher. In some instances, the brokerage firm will force the short seller to buy the securities in the market before the settlement date, which is referred to as a forced buy-in. A brokerage firm may require a forced buy-in if it believes that the shares will not be available on the settlement date.
How Margin Accounts Are Used
The Federal Reserve Board’s Regulation T requires that all short sale trades must be placed in a margin account. A margin account requires the investor to deposit 150% of the value of the short sale trade. If, for example, an investor’s short sale totals $10,000, the required deposit is $15,000.
Since short sellers are exposed to unlimited losses, a substantial deposit is required to protect the brokerage firm from potential losses in a customer’s account. If the price of the security increases, the short seller will be asked to deposit additional dollars to protect against larger losses when the stock is eventually purchased.