In a short sell does the broker who loaned you the shares earn interest on them? How does he make money?

Question

Essentially i'm wondering why a broker would loan you the shares in the first place if the stock's price will be likely to go down. He must earn some form of interest to make the loan worthwhile. Is the some kind of connection between this kind of a loan and a regular monetary loan from the bank?

Answer 1

In a short sale, you would in effect borrow shares from a broker's inventory, and sell them, with the hope of being able to buy those shares back at a lower price than what you paid, in order to produce a profit. How the transaction works is that you would borrow the shares from the broker, and then immediately sell them. At that point, you would pay a commission on the sale of the shares. Furthermore, you would then begin to accrue and pay what's called "margin interest" on the entire market value of the short position, for as long as that position is "open". Later, when you elect to "close" out your short position, you would pay another commission on the purchase of the shares (which would go back to the broker, to replace the shares that you originally borrowed).

As for the issue of why the broker would "loan" the shares in the first place, a key aspect of short selling is that you are borrowing shares that are held in the broker's inventory. Before you place a short sale, one of the thing's you must find out, is whether or not the security you want to "short" is available for short sales. Not all stocks can be shorted. From the broker's point of view, on an aggregate level these transactions generate millions of dollars worth of revenue, from the commissions (paid both ways) and from the "margin" interest that's earned on the short positions. This is revenue that is generated from assets that would otherwise just be sitting in inventory. The broker wins either way, regardless of what direction the market moves. This is a form of what's called "securities lending", which is a significant source of revenue for all broker dealers.

In general there is not much of a connection between a typical consumer loan, and a loan of shares for the purpose of a short sale. You would not be able to effect the same transaction by borrowing money from a bank. In order for the short sale to work, you have to borrow and sell someone else's shares, with the hope of buying them back at a lower price than what you sold them for.

Answer 2

You know that each publicly traded company is divided into shares. If XYZ Company has 100 million shares trading at $10/share, then the current value of the company is 1 billion dollars. Also keep in mind each of those 100 million shares has an owner regardless of whether the stock is going up or falling like a rock. So, if the stock price goes down to $5, the total loss of all the investors is half billion dollars. What would happen if an investor decided to sell short 30 million shares? Theoretically, the company would have 130 million shares outstanding. When these 130 million shares go down in value from $10 to $5, that's a loss of 650 million dollars. Without the short sale, the total loss of all the investors would have been 500 million dollars. The difference is 150 million dollars, which is the profit for the short seller. Who loses? When a short sale occurs, the borrowed shares go on sale, and somebody BUYS them. Whoever buys those new shares before going off the cliff are the losers. It could be investors like you and me or funds or banks or your broker or whoever is buying those shares at the time--anybody. On the other hand, if the short seller makes a mistake, then his entire loss becomes the investors' gain. Let's consider this scenario: If the company is $5 and X trader decides to sell short 30 million shares and the next day the stock opens at $10, he must buy back 30 million shares at $10/share. That's a half-billion-dollar loss. The investors who sell him the 30 million shares at $10 are profiting from his loss. SHORT SELLING is a zero sum game. The short seller's profit is always another person's loss. And the short seller's loss is always another investor's gain. The money involved in short selling is never wiped out. It simply moves from one pocket to another. (In reality, if anybody tries to buy or sell 30 million shares of a 100-million-share company, the buying or selling will move the price significantly. But I did not mention this to keep things simple.)

Answer 3

No, it is just a transaction..there is never any telling whether it will go up or down. If that was true, he would charge interest to the shareholder going long as "it has to go up"

It's a zero sum game, some win money and some lose..but the broker makes money either way off of the transaction totals.

Answer 4

He earns money on the interest you pay him for loaning you the stock. He doesn't care if the stock goes up or down or it you make or lose money. You borrow the shares from him and pay him interest.

He also makes a commission on both the short sale and when you eventually cover.

Answer 5

I don't think theres interests because the point of selling short is when you get that loan you buy guarantee on that stock price at that time. I think he just get commission like in other trades. I'm not sure though.