There is no mandated limit to how long a short position may be held. Short selling involves having a broker who is willing to loan stock with the understanding that they are going to be sold on the open market and replaced at a later date.
- There is no set time that an investor can hold a short position.
- The key requirement, however, is that the broker is willing to loan the stock for shorting.
- Investors can hold short positions as long as they are able to honor the margin requirements.
A short position may be maintained as long as the investor can honor the margin requirements and pay the required interest and the broker lending the shares allows them to be borrowed.
While both those statements seem obvious, they are in fact the greatest limitations to an investor's ability to hand on to their short positions. Looking at them one at a time makes this a little more transparent:
- Honoring the margin requirements: A rapid rise in the value of the shorted security can easily wipe out the available cash an investor has elsewhere, especially if they've been caught in a short squeeze.
- Paying the interest: This assumes that a short, which goes nowhere, can quickly become unprofitable in a rising interest rate environment.
- The broker allows borrowing: This can become problematic if companies try to limit the amount of the underlying in circulation.
Why Short Stocks
Investors short stocks anticipating that the market price will fall, allowing them to buy shares to replace them at a lower price. Stocks are shorted by many investors every day. Some specialize either largely or exclusively in short selling.
A stock that doesn't decrease in value quickly enough ends up costing the investor interest. The proceeds of the initial sale go into the investor's account and they pay the broker a percentage, which is usually around the U.S. prime rate plus 2%. At any point in time, the investor may buy replacement shares on the open market and return them to the brokerage.
If they can buy them at a lower price, the investor keeps the difference as a profit. If the price is higher, the investor suffers a loss.
Brokers and Shorting
For skilled investors, the terms offered by brokers for short selling can be quite favorable. Making stock available to be shorted at an interest rate just a few percentage points above prime appears to be a very good deal.
The price of the shares can be much lower at the time of purchase, and the broker will have only received a small percentage of their original value. This suggests that brokers regularly suffer significant losses in the share-lending business. Nevertheless, share lending is very profitable for brokerages.
The Bottom Line
Investors may find that the best candidates for short selling are unavailable to be shorted. The availability of stocks for shorting changes regularly. Many stocks offered by smaller companies may not be available for shorting at all.