Short Positions

When a customer sells short, he sells borrowed securities in anticipation he can replace them at a lower price. So, if he wants to sell short $10,000 worth of securities, he must deposit half that value, $5,000, to meet the Reg T requirement. If he did, his account would look like this:
Cr            $15,000
SMV      - $10,000
Equity        $5,000

The "Cr" stands for the "credit" and the "SMV" stands for "short market value," or, perhaps, we could just call it the "market value." In any case, when the customer sells short $10,000 worth of securities, that $10,000 is credited to the customer's account. Remember, he sold some stock someone paid him $10,000.

So, our investor gets the proceeds from the sale, and deposits another 50% of that to meet the Reg T requirement. The $10000 he took in for selling the stock, plus a $5,000 cash deposit, equals a total credit of $15,000.

If the "SMV" goes down, as the investor hopes, he'll have more equity. For example, if the SMV dropped to just $5,000, the customer's equity would increase by $5,000, like this:
Cr            $15,000
SMV      - $5,000
Equity        $10,000

The credit didn't change. He started with a credit of $15,000, and that's all the credit he's going to have. It's the market value (SMV) that changed, dropping in the desired direction for our short seller.

And if the market value of the securities sold short were to increase, his equity would shrink, like this:
Cr            $15,000
SMV      - $11,000
Equity        $4,000

How high can the SMV go before a customer gets one of those nasty maintenance calls? For most short positions, customers need 30% of their SMV as equity. If the customer's SMV is $11,000, he needs at least $3,300 in equity. You can find the highest SMV at maintenance by taking the "Cr" and dividing it by 1.3. Since the customer has a credit of $15,000, just divide that by 1.3, and you see that the highest SMV without a maintenance call is $11,538. If the securities' value doesn't exceed that number, his account will remain properly margined.

Combined Equity
To find combined equity, find the equity for the long positions and add it to the equity for the short positions. You can also remember that the formula for combined equity is:
LMV + Cr - Dr - SMV
Which is just another way of saying, `Add the two things that go on top and subtract the two things that go on the bottom." So, if a customer had an LMV of $20,000, a Cr of $20,000, a Dr of $10,000, and SMV of $10,000, his combined equity is $20,000:
LMV      + Cr      - Dr       - SMV
20،000 + 20،000 - 10،000 - 10،000

He has $10,000 equity on the long positions, and $10,000 equity on the short pos¬itions. He must have 25% equity for the long, and 30% for the short. This customer is okay on both fronts Each day the markets are open, the margin department recalculates requirements by marking to the market. If market values have gone the wrong way, the customer might receive a margin call. If market values have gone the right way, the customer might see SMA increase.

Locating and Borrowing
The SEC does not like it when short sellers sell shares that don't exist. Allowing them to do so would distort the downward (bearish) pressure on a stock by distorting the laws of supply & demand that determine the stock's market price. Therefore, under Regulation SHO, broker-dealers must locate the shares their customers are selling short and document it before effecting the short sale.

That means they reasonably believe the securities can be delivered by the settlement date as required. Such securities are located through the lending programs.

The regulators have other concerns about short selling and its potential impact on the market. Many years ago, a short sale could only be executed at a price that was higher than the previous price for the security, or at the same price if the price before had been an "uptick."

In May 2010 Reg SHO was updated to impose a temporary version of the old uptick rule that applies when a "circuit breaker" is tripped for a security. Starting in May of that year if a security dropped during the day by 10% or more below its most recent closing price, short sellers would not be able to sell short at or below the current best bid price for the security. In other words, people "selling long," which means selling the shares they own, will have priority and will be able to liquidate their holdings before short sellers can jump onto the pile.

As the SEC states:
a targeted short sale price test restriction will apply the alternative uptick rule for the remainder of the day and the following day if the price of an individual security declines infra-day by 10% or more from the prior day's closing price for that security. By not allowing short sellers to sell at or below the current national best bid while the circuit breaker is in effect, the short sale price test restriction in Rule 201 will allow long sellers, who will be able to sell at the bid, to sell first in a declining market for a particular security. As the Commission has noted previously in connection with short sale price test restrictions, a goal of such restrictions is to allow long sellers to sell first in a declining market. In addition, by making such bids accessible only by long sellers when a security's price is undergoing significant downward price pressure, Rule 201 will help to facilitate and maintain stability in the markets and help ensure that they function efficiently. It will also help restore investor confidence during times of substantial uncertainty because, once the circuit breaker has been triggered for a particular security, long sellers will have preferred access to bids for the security, and the security's continued price decline will more likely be due to long selling and the underlying fundamentals of the issuer, rather than to other factors.

As we see from that passage, there is a difference between a customer sell order marked "long" and a sell order marked "short." That is why Reg SHO requires all sell orders to be marked properly. When a customer "sells long," he is liquidating shares that he owns. To sell short, he borrows shares that will be sold and then re¬placed later by the customer.
Short sales take place only in margin accounts, not cash accounts. Cash accounts do not involve borrowed money.


Get in touch!


Email *

Message *