Restrictions and Borrowing Costs

Q:What are the limitations/restrictions on short selling?

A: Long and short trades with CFDs are simply mirror images, they are exactly the same, margin calls, guaranteed stop losses all work the same way. Providers control their risk by limiting positions, not by closing you out. I am currently long on a stock with a CFD but cannot buy any more with a guaranteed stop because the provider has a limit that it is comfortable being able to honour that stop at. They don’t just close me out when they feel like it or they get sued

With CFDs, you do not borrow the stock, you have no direct legal or contractual relationship with the lender of the stock. That relationship exists between the CFD provider and the institution or broker whom they borrow the stock from, to facilitate your trade. Once they feel they have borrowed sufficient stock against their risk parameters they won’t offer a short position. Your relationship is with the CFD provider and they must honour both short and long positions when you choose to close them.

What are the limitations/restrictions on short selling?

To start with you need to have a margin account in order to sell shares short. A margin account allows the broker to extend credit to you.

There are various other restrictions on the size, price and types of stocks you are able to short-sell. For instance, many CFD brokers impose large margin requirements on clients who short stocks with a low market capitalisation or stocks which tend to experience wild swings. Also, for highly illiquid stocks where only limited amounts are available for borrowing (or in instances where the holders of the stock simply aren’t prepared to lend the stock), then it just won’t be possible to short that individual company’s shares. Before July 2007 the SEC also enforced an uptick rule requiring every short sale transaction to be entered at a higher price to the previous trade (thus keeping short sellers from continuing to add downward pressure to stocks which are already experiencing share falls) – this rule has now been been removed. Remember also that since you do not own the security you must pay the lender of the stock any dividends or rights declared during the holding period. This means that should the stock experience a ‘split’ during the course of your short, you’ll owe twice the number of shares at half the price.

Stocks usually have to be borrowed before they can be sold short, so if a broker or fund is not ready or unable to lend their holding, shorting may not be possible. Lastly, in most cases you can hold a short for as long as you please, however in certain cases you may be forced to cover if the lender wants the stock back (which you borrowed). As a CFD provider can’t sell what they don’t have they will either have to come up with new shares to borrow or you’ll have to cover (aka as ‘being called away). This can result in a short squeeze and clients being forced to close out trades prematurely. This is not to say that it happens oftens but you need to be aware of this possibility if you are short-selling a security.

Note there are no such restrictions when shorting indices using CFDs as these are linked and hedged to the underlying futures contracts. Index CFDs are practically quoted on a continual basis so opening or closing positions shouldn’t be a problem.

Q: What if a stock is listed that it cannot be short sold?

A: Every broker has a certain exposure limit which they adhere to on short positions usually based on the amount of shares they have borrowed/acquired. Once they exceed that limit, then they can’t open any new short positions.

So what happens if a CFD provider uses up all their stock on loans and limit set by themselves? Well, in that case they need to either borrow more stock which they could then give their clients to sell and open short positions or just don’t accept any more shorts until they become net available again.

If you go long, then a CFD company just buys shares and takes the same position (long in the market) while if you wish to short a stock, they need to use borrowed shares and then pass it to you to sell and be short. They could do naked shorting (i.e. accept your sell order before borrowing the shares) but this is risky if the market is rising and shares may be in short supply.

In practice, unless the CFD provider is selling stock in a company where they already have a long position, then the stock has to be borrowed for a short-sale to be possible. This also means that CFD providers have the same restrictions as conventional brokers, supposing for instance that the Australian authorities limit short-selling on a number of financial stocks, then the CFD provider won’t be in a position to offer these companies as shorting candidates to clients.

Having said that I don’t encounter shorting restrictions often enough for it to be an issue for me. Occasionally on a stock in a downtrend that is already heavily shorted, there may be no more shareholders prepared to lend out their stock for shorters to play with – which is fair enough. On smaller stocks where liquidity is limited at the best of times, I expect shorting to be limited occasionally. In the past I have found Carpetright (CPR) to be unshortable. I suppose it is feasible that a board of directors might persuade their biggest institutional shareholders to not assist shorters by loaning stock. Overall I don’t regard such situations as anything sinister or suspicious.

So, what if a stock is listed that it cannot be short sold? First, give a call to your broker; in quite a number of cases the provider can still allow you to take the position. However, in such cases you might be charged a daily borrowing fee (since the broker may incur higher costs) but at least you are able to take the deal. In cases where you simply can’t short a particular company’s shares, you could always use a stock index or sector CFD to try profiting from the wider market. In practice, it is best to stick to very liquid stocks like FTSE 250 shares when short-selling. This will at least allow you to exit the position if the market moves against you.

Q:I’m being charged a borrowing cost for my short position. What is that?

I’ve been checking my Betsson short and I noticed that everyday I’m being charged two separate amounts; typically -:

Stock Borrowing Costs: SK-7.94
CFD funding Interest Paid: SK-11.11

I do understand being charged financing (i.e. negative interest) on short positions due to the LIBOR rate being less than the -2.5% but I don’t understand the additional fee? Am I being charged a stock borrowing fee as well as a CFD funding interest to hold this short position? I thought brokers only charged a CFD funding fee to hold a short?

A: Betsson is a Swedish stock listed on the Stockholm exchange thus traded in SEK.

Note that when you open a short share CFD position, you may incur a ‘borrowing charge’ which will be subtracted from the relevant applicable annual interest rate. You will only incur a borrowing charge if your broker also incurs such a charge when they open a hedging trade in respect of the same share in the underlying market; and they usually pass the charge onto you with no mark up.

Note also that the interest charges and stock borrowing charges are two separate things and stock borrowing charges only apply to certain shares and at certain times. Whereas, adjustments to reflect the effect of interest are calculated daily and posted to your account daily i.e. the overnight funding charge applies in order to reflect the effect of interest. Interest on long positions is debited from a client’s account; on short positions, there may be a credit or a debit depending on the respective annual interest rate. Effectively, due to the low annual interest rates, interest is currently debited by most brokers from a client’s account regardless whether you are long or short. If the annual interest rate is 2.5% (the broker’s interest rate) or more then you will be credited interest for short positions.

To determine whether a borrowing charge also applies, it is best to call or send an e-mail to your broker in advance of trading. The borrowing charge, and your ability to go short, can be changed at short notice.

Q:Why do some companies or brokers impose borrowing costs on one stock and don’t impose such a fee on others?

A: Please be advised that it is your CFD provider’s brokers (whom your CFD provider opens the client’s positions with) or the companies themselves that impose stock borrowing charges and the CFD provider has no influence on why and when these charges occur. However, if stock borrowing charges apply your CFD provider will then charge you accordingly to reflect this.

To explain: Whenever you go short you sell assets which have been ‘borrowed’ from a third party with the intention of buying identical assets back at a later date to return to the lender. Hence, the lender may or may not impose a borrowing charge. Note that it is up to the individual lenders to impose this charge and therefore this charge is up to their discretion.

Q:Are there any differences in short selling between a Market Maker as opposed to a Direct Market Access Broker?

A: Yes, there can be differences. A market maker is able to allow you to short whichever stocks they please but most providers will want to offset their exposure. Most CFD market makers will hedge a certain percentage of client orders into the market but most of the times they will also be running their own ‘book’. Any exposure not hedged will ultimately lie on their books and should the shares that your broker is unable to physically short-sell themselves keep falling, then their exposure will similarly increase. They could use the futures market to offset some of this exposure but this may not provide sufficient cover.