Shareholders may buy a stock in part to receive the dividend payments handed to owners of the company's stock. Dividends represent a distribution of profits to equity owners, where common shareholders of dividend-paying firms are eligible to receive them as long as they own the stock by the ex-dividend date.
But what happens if you sold short a dividend-paying stock? Read on to learn the answer.
- Investors who own stocks long are typically entitled to dividend payments for dividend-paying companies.
- If, however, you are short a dividend-paying stock, you are not entitled to receive the dividend and may actually have to pay the lender of the borrowed short shares.
- It is important to note exactly when you sold the shares short. If the stock is short on the record date, they will owe the dividend to their broker.
Important Dividend-Related Dates
Dividend payments follow a chronological order of events, and the associated dates are important to determine the shareholders who qualify for receiving the dividend payment:
- Announcement date: Dividends are announced by company management on the announcement date, and must be approved by the shareholders before they can be paid.
- Ex-dividend date: The date on which the dividend eligibility expires is called the ex-dividend date or simply the ex-date. For instance, if a stock has an ex-date of Tuesday, June 5, then shareholders who buy the stock on or after that day will NOT qualify to get the dividend as they are buying it on or after the dividend expiry date. Shareholders who own the stock one business day prior to the ex-date—that is on Monday, June 2, or earlier—will receive the dividend.
- Record date: The record date is the cut-off date, established by the company in order to determine which shareholders are eligible to receive a dividend or distribution.
- Payment date: The company issues the payment of the dividend on the payment date, which is when the money gets credited to investors' accounts.
Short Stocks and Dividend Payments
Shorting a stock is essentially selling it and then buying it back at a future price. If the price falls, there is a profit. If the price rises, there is a loss. The stock needs to be borrowed from a shareholder to sell it without owning it. A brokerage firm usually handles this process. There is generally a borrowing fee for the stock, depending on its availability and liquidity. Additionally, the borrower of the stock is responsible for paying any dividends.
If an investor is short a stock on the record date, they are not entitled to the dividend. In fact, the investor is instead responsible for paying the dividend owed to the lender of the shorted stock that they borrowed. Investors short a stock if they expect it to decline in value.
Shorting stocks are considered risky and appropriate only for sophisticated traders due to the general upward trend of stocks, borrowing costs, and the skewed risk-reward nature of shorting. Over time, stocks appreciate as inflation erodes the value of currencies. Companies, through their business operations, protect against inflation as they can pass on rising costs to customers. This is one reason for the general upward trajectory of stock indexes over time.
Borrowing costs can be significant depending on the stock, typically between 2% and 10% annually. Of course, there is the additional cost of paying out dividends. This is a significant drag on returns and compounds the difficulty of the task. Finally, basic math works against short selling as well. A stock can go up by multiples if there is a takeout offer or the company comes out with some innovative product.