How does stock shorting work?


Specifically, how does one “borrow” or “sell” stock they don’t actually own?

In: 8

Typically when you’re borrowing the stock, you’re signing a contract of sorts that says you will pay a certain fee up front plus interest on the value of the stock until you return it/the contract expires. The person lending the stock typically comes out ahead regardless since they get some money and the guarantee that their stock will be returned.

Step 1: You borrow a stock from broker.

Step 2: while borrowing, you and broker agree on contract

Step 3: contract states you are borrowing stock from broker to sell it and then purchases the same stock from open market.

Step 4: After purchasing it back you are returning that stock back to broker on or before specific date and time.

Why short it?
If you feel that stock will be valued less in next 4 hours then you short sell it at $100, and if its market value goes down in 4 hours, let’s say $90. Then you purchase it back at $90.

$10 is your gross profit.

The typical investor doesn’t do the borrowing directly. A typical investor opens an account with a brokerage and, if qualified, are given stock shorting privileges. The investor enters a request to short the stock and the brokerage does the rest. The broker borrows the shares on behalf of the investor and sells the stock. In order to do a short sale, the investor must have enough funds in their account (by SEC regulations)

The investor pays a fee for this. When they close the short position, their gain or loss is recorded. If the stock appreciates a lot during the period of the short, ie the short begins to lose a lot of money, the investor will likely receive a margin call and be required to top up their brokerage account.

To a typical investor, this operates as the “reverse” of buying a share ie it is a contract that makes more gains the more a share price falls. The mechanics are all done by the broker.

The long and short of it is accumulating profit regardless of the harm caused to the corporation and other stock holders. On the surface this seems unethical if not immoral. Yet this is legal.
Similarly those who take over a company, then gut it and then mark up product prices exponentially. Think of insulin. Again all legal.

It’s not that different from borrowing money to buy a house or car…. Banks/brokerage lend out other customers’ money/shares. You repay the loan or cover the short and the money or shares are returned to customers. It’s done on an abstract basis, ie. if you own shares or have money in a bank, they’re not going to tell you that you can’t sell your shares or pull out money because it’s being lent to another customer.