What Is a Sellout?

The term sellout refers to a situation in finance in which investors are forced to sell their assets. Sellouts commonly occur when an investor is compelled to sell their assets because of non-economic factors. A common example of a sellout is 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 are different from sell-offs, which are triggered by economic considerations such as the fear that a certain industry or sector will be negatively affected by a given event.

Key Takeaways

  • A sellout is a situation in which investors are forced to sell due to non-economic considerations.
  • Common examples include illness, divorce, and margin calls.
  • Sellouts can present attractive opportunities for investors to buy low, such as in the case of a short squeeze.

Understanding Sellouts

A sellout is a situation in which investors are forced to sell their shares due to non-economic considerations. Sometimes, these situations occur because of personal events such as an unforeseen illness or a divorce. In the financial markets, however, more common causes of sellouts are the margin calls associated with leveraged margin accounts.

Sellouts are commonly caused by margin calls associated with leveraged margin accounts.

To understand this phenomenon, it is helpful to first review the basic business model of brokerage firms. Brokerage firms essentially act as middlemen between the buyers and sellers of securities. They generate revenue from commissions placed against their clients' transactions as well as various administrative fees. In the case of broker-dealer firms, they can also hold inventory in the securities their clients buy and sell, obtaining a profit from the spread between their buy and sell prices.

Another way brokers generate profit is by lending money to their clients. These so-called margin accounts allow investors to make leveraged trades. When making long investments, this is accomplished by borrowing money from the broker and then using it to purchase shares. When making short investments, it is done by borrowing the shares themselves from the broker and then selling them immediately for cash. 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.

In order to manage their risks, brokers carefully monitor the market value and collateral level of their clients' margin accounts. If the level of collateral dips below their minimum threshold, 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. If this liquidation occurs, the resulting transactions would be a type of sellout, since they are being executed in a forced manner.

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Example of 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 in order 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.