Personal Finance & Money Asked by DaleSwanson on July 12, 2021
Thinking about the current situation where GME has been shorted by more than the existing float, I think I have a basic understanding of short selling as selling shares you’ve borrowed. I’ve seen a number of reasons proposed for why the holders of these short shares may be forced to cover their shorts, but I’ve also seen each of these reasons called out for not being true. Here are the four reasons I’ve seen, as well as the counters:
Counter: The interest rate is low, and much less than covering would cost.
Counter: This is temporary, and better than the cost to cover.
Counter: This applies to put options, but not to short sales.
Counter: This is either not true, or not likely in this case
So which, if any, of these is actually true, (and conversely, which, if any, of the counters is not true)? Is it the combination of multiple ones?
Or is it the case that they can in fact hold their positions as long as they’re confidant the price will drop a lot, and that there is just a temporary cost of maintaining?
EDIT: I understand there is no guarantee that the price will go back down. However, for the sake of this question let’s assume that at the very least the short sellers are confident that the price will be significantly lower (a tenth) in a couple months, than it is now. They desire to simply wait for that, can they do that, regardless of if they are wrong?
Your question assumes that eventually "the price goes back to normal". There is no guarantee that will happen. Short sellers have experienced large losses but also an increase in the risk of further losses, as the stock has become extremely volatile.
What was originally a $1 million short position, for example, may have become a $20 million short position that is now extremely leveraged (since the short seller's portfolio equity has declined while their exposure has increased).
Volatility can go in either direction, and leveraged losses are particularly destructive. So covering shorts may be a matter of surviving, versus continuing to put up more money for margin until going broke.
Answered by nanoman on July 12, 2021
You're conflating several issues and assuming that one is better than the other. OK, one by one:
This has nothing to do with much less than covering would cost. Covering is a decision to either book gains or limit further losses.
A 40% borrow rate is high for normal situations but surprisingly low for what has been going on with GME. I recall Tilray being over 900%.
They must put up large sums of money as margin calls.THIS IS THE BIG PROBLEM. Per Reg T, shorting requires 50% initial margin and the margin maintenance requirement (MMR) is 30% (brokers can require more).
I'll spare you the intricate details of the math but if you short on 50% margin with a 30% MMR, you have about 15% buffer until you need to provide more margin. For example, short 100 shares at $20. A bit above $23, you'll need to add more margin. After that, for every $1 that the stock rises, you'll need another $130 of margin in your account. If not, your broker will close your position. If GME goes to $400, along the way you'll have to have added a bit over $49k to your account on the way up in order to remain short 100 shares at $20. OUCH
There is no expiration date with short selling equities.
The loaner of the loaned shares only demands them back if the owner sells them and his broker cannot find replacement shares. Otherwise, you can remain short as long as you want to, assuming that you are solvent (see the $49k above).
Answered by Bob Baerker on July 12, 2021
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