Sellout

What Is a Sellout?

In the context of finance and investing, the term “sellout” refers to a situation in which individuals or firms are forced to sell some or all of their assets to satisfy certain short-term obligations that cannot be met otherwise.

Sellouts can occur when an investor experiences substantial losses in a margin account. An example of a sellout would be a margin call, in which a broker forcefully liquidates a margin trader’s portfolio based on that trader’s failure to maintain adequate collateral.

Sellouts should not be confused with sell-offs, which involve a rapid decline in the prices of assets due to substantial selling pressure.

Understanding Sellouts

A sellout occurs when assets are forced to be sold. Sometimes, these situations occur because of personal events such as an unforeseen illness, a lawsuit, or a divorce. Firms may be forced to liquidate their assets in the event of a bankruptcy, sometimes at fire sale prices that are below current market value. The point at which a sellout will commence is sometimes known as the liquidation level. Note that the amount of assets sold often will be limited to the value needed to satisfy the short-term obligation that triggered it.

The point of a sellout is to quickly generate cash to satisfy short-term obligations that must be met. As a result, the one forced to sell may not always get the most favorable prices or terms.

In the financial markets, a common cause of sellouts are the margin calls associated with leveraged margin accounts.

Sellouts to Satisfy Margin Calls

Margin accounts allow investors to make leveraged trades, effectively amplifying the profit potential of a position. When taking long positions on margin, the investor or trader effectively borrows money from their broker and then uses that loan to purchase additional shares. When taking a short position, the shares themselves are borrowed from the broker and are sold short. The short seller then hopes to repurchase those shares in the future at a lower price, returning those shares to the broker and profiting from the difference.

To manage the risks associated with such loaned money, brokers carefully monitor the market value and collateral level of their clients’ margin accounts. If the level of collateral dips below their minimum threshold (known as the maintenance margin), the broker issues a margin call to the investor notifying them that if they do not post additional collateral to their account, the broker will forcefully liquidate their portfolio to generate the cash needed to satisfy the outstanding loan balance. This amount is set by regulation at a minimum of 25% of the account’s value, although a brokerage may require a higher amount. If this liquidation occurs, then the resulting transactions would be a type of sellout, since they are being executed in a forced manner.

Opportunities Arising from a Sellout

Sellouts can sometimes present attractive buying opportunities. For instance, if a heavily shorted stock continues to rise, the short sellers of that stock will see steadily mounting losses to their short positions. If this situation persists long enough, many of those short sellers will likely face margin calls from their brokers.

This situation can lead to a so-called short squeeze. In this case, growing numbers of short sellers are forced to buy the shorted stock to cover their short positions. In these circumstances, opportunistic investors might profit from the sellout by buying the shorted stock prior to the short squeeze, since the forced buying from the short sellers might place additional upward pressure on the company’s stock price.

In the world of business, a sellout can also provide an opportunity to purchase assets “on sale,” or to take over a struggling firm entirely at rock-bottom prices. So-called vulture investors specifically look for such struggling firms and snatch them up when the sellout takes place.