Who Benefits From Lending Shares in a Short Sale?

A flash sale is a common type of trading in the financial world. It involves selling an asset that a trader does not own. The trader borrows the asset and then, at a specified future date, buys it back and returns it to the owner of the asset. The investment philosophy is that the price of the borrowed asset will fall and the investor will make a profit by selling at a higher price and buying back at a lower price. The short sale is made on margin and is a risky business due to its unlimited loss potential.

To determine who benefits from lending stock in a short sale, we must first clarify who is lending in a short sale transaction. Many individual investors believe that since it is their shares that are loaned to the borrower that they will receive some benefit, but this is not the case.

Benefits of stock lending

When a trader wishes to take a short position, he borrows the shares from a broker without knowing where the shares come from or to whom they belong. Borrowed shares can come from another trader margin account, on stocks held in the inventory of the broker, or even of another brokerage firm. It is important to note that when the trade has been placed, the broker is the lending party, not the individual investor. Thus, any advantage received (as well as any risk) belongs to the broker.

The broker receives an amount of interest for lending the shares, and also receives a commission for providing this service. In case the short seller is unable (due to bankruptcy, for example) to return the shares it has borrowed, the broker is responsible for returning the borrowed shares. Although it is not a huge risk for the broker due to margin requirementsthe risk of loss is always there, and that is why the broker receives the interest on the loan.

See also  Independent Tether attestation reveals 58% decrease in commercial paper holdings

In the event that the stock lender wishes to sell the stock, the short seller is generally unaffected. The brokerage firm that lent the shares in a client’s account to a short seller will generally replace the shares in its existing inventory. The shares are sold and the lender receives the proceeds of the sale in his account. The brokerage firm is still liable for the actions by the short seller.

The primary reason the brokerage – not the person holding the stock – receives the benefits of stock lending in a short sale transaction can be found in the terms of the margin account agreement. When a client opens a margin account, there is usually a clause in the contract that states that the broker is authorized to lend, to itself or to others, the securities held by the client. By signing this agreement, the client waives any future benefit of having his shares loaned to other parties.

The essential

Short selling is a risky trade but can be profitable if executed correctly with the right information to support the trade. In a short sale transaction, a broker holding the shares is usually the one who benefits the most, as he can charge interest and commissions on the loan of the shares from his inventory. The beneficial owner of the shares does not benefit due to the stipulations set out in the margin account agreement.

Disclaimer: Curated and re-published here. We do not claim anything as we translated and re-published using Google translator. All ideas and images shared only for information purpose only. Ideas and information collected through Google re-written in accordance with guidelines and published. We strictly follow Google Webmaster guidelines. You can reach us @ chiefadmin@tipsclear.com. We resolve the issues within hour to keep the work on top priority.

See also  Moving Average Envelopes: A Popular Trading Tool