A short sale is a common type of trade in the financial world. It involves selling an asset that a trader does not own. The trader borrows the asset, then—by a specified later date—buys it back and returns it to the asset's owner. The investment philosophy is that the borrowed asset will decline in price and the investor will earn a profit by selling at a higher price and buying back at the lower price. Selling short is done on margin and is a risky endeavor due to its unlimited potential for loss.
In determining who benefits from lending shares in a short sale, we first need to clarify who is doing the lending in a short sale transaction. Many individual investors think that—because their shares are the ones lent to the borrower—they will receive some benefit, but this is not the case.
Benefits From Lending Shares
When a trader wishes to take a short position, they borrow the shares from a broker without knowing where the shares come from or to whom they belong. The borrowed shares may be coming out of another trader's margin account, out of the shares held in the broker's inventory, or even from another brokerage firm. It is important to note that when the transaction has been placed, the broker is the party doing the lending, not the individual investor. So, any benefit received (along with any risk) belongs to the broker.
The broker does receive an amount of interest for lending out the shares and is also paid a commission for providing this service. In the event that the short seller is unable (due to a bankruptcy, for example) to return the shares they borrowed, the broker is responsible for returning the borrowed shares. Though this is not a huge risk to the broker due to margin requirements, the risk of loss is still there, and this is why the broker receives the interest on the loan.
In the event that the lender of the shares wishes to sell the stock, the short seller is generally not affected. The brokerage firm that lent the shares from one client's account to a short seller will usually replace the shares fromits existing inventory. The shares are sold and the lender receives the proceeds of the sale into their account. The brokerage firm is still owed the shares by the short seller.
The main reason why the brokerage—not the individual holding the shares—receives the benefits of lending shares in a short sale transaction can be found in the terms of the margin account agreement. When a client opens a margin account, there is usually a clause in the contract that states that the broker is authorized to lend—either to itself or to others—any securities held by the client. By signing this agreement, the client forgoes any future benefit of having their shares lent out to other parties.
The Bottom Line
Short selling is a risky trade but can be profitable if executed correctly with the right information backing the trade. In a short sale transaction, a broker holding the shares is typically the one that benefits the most, because they can charge interest and commission on lending out the shares in their inventory. The actual owner of the shares does not benefit due to stipulations set forth in the margin account agreement.
FAQs
In a short sale transaction, a broker holding the shares is typically the one that benefits the most, because they can charge interest and commission on lending out the shares in their inventory. The actual owner of the shares does not benefit due to stipulations set forth in the margin account agreement.
Why do people lend shares to short sellers? ›
Lending your stocks to short sellers can generate extra income from your long-term holdings, but be sure you understand the risks and other considerations before you get started. Most investors purchase a stock hoping it'll rise in value—but short sellers want the opposite.
Who benefits from stock lending? ›
For shareholders, stock lending offers a relatively low-risk way to earn extra returns on the stocks you already own. You maintain ownership of your stocks the whole time. If loaned stocks go up in value, those returns are still yours. If you decide to sell your stocks while they're loaned out, you can.
How do lenders make money on short selling? ›
By facilitating shorting, and presumably taking a cut of any profit or charging the borrower a fee, the lender gets to keep the share whilst participating in any fall in value which, after receiving the cut or fee, might compensate for any drop in value.
Who do short sellers borrow shares from? ›
Short selling a stock is when a trader borrows shares from a broker and immediately sells them with the expectation that the share price will fall shortly after. If it does, the trader can buy the shares back at the lower price, return them to the broker, and keep the difference, minus any loan interest, as profit.
Why would someone lend shares? ›
When investors lend their shares to a broker, they can receive more income over time. Loaning a stock or another asset such as an exchange-traded fund to a brokerage firm can yield investors more income passively. Securities lending is common, and share lending programs are usually conducted by brokerages.
Is share lending a good idea? ›
If you own a large position in one or more stocks, lending your shares can be an easy way to earn passive income from your idle investments. Stock lending programs give you cash payments every time your shares are lent out, which you can reinvest, put toward diversification, or spend on other expenses.
Is there a downside to stock lending? ›
The main risks are that the borrower becomes insolvent and/or that the value of the collateral provided falls below the cost of replacing the securities that have been lent. If both of these were to occur, the lender would suffer a financial loss equal to the difference between the two.
What are the disadvantages of stock lending? ›
Since the price of a share can fluctuate with market demand, the value of the stock used to secure a loan is not guaranteed over the long term. In situations where a stock loses value, the collateral associated with a loan may become insufficient to cover the outstanding amount.
What is the average income for a stock lending person? ›
Securities Lending Analyst Salary
| Annual Salary | Monthly Pay |
|---|
| Top Earners | $111,500 | $9,291 |
| 75th Percentile | $76,000 | $6,333 |
| Average | $72,854 | $6,071 |
| 25th Percentile | $61,000 | $5,083 |
Cons
| Pros and Cons of Share Lending |
|---|
| Pros | Cons |
|---|
| Potential to earn more revenue | Lack of SIPC protection |
| Allows investors to boost returns from dormant investments | Increased counterparty risk (the borrower may default) |
| Adds liquidity to short-seller market | You're taxed at the marginal rate on payments in lieu of dividends |
1 more rowThe only case where your broker might lend your securities without your knowledge is when you have a margin account and you are actually borrowing money. > brokers cannot lend your shares without a written agreement allowing it.
What are the best stocks for stock lending? ›
Keep more of your money
Hard-to-borrow high-growth stocks usually trade at high lending rates. For example: LCID generated the most revenue in 2022, and often traded at 5%+ over the year. VISA, TSLA, UBER, LYFT, UPST are some of the highest earners over the last few years.
How long can you borrow shares to short-sell? ›
There is no mandated limit to how long a short position may be held.
How do you prevent short sellers from borrowing your shares? ›
The detailed instructions contrast with the much simpler instructions posted initially Wednesday in the FAQ, which just said, "To prevent shares from being loaned for a short interest position, contact your brokerage to place restrictions on the lending of your shares to short sellers."
Can you short-sell without borrowing? ›
In essence, you deliver borrowed shares. Another form is to sell stock that you do not own and are not borrowing from someone. Here you owe the shorted shares to the buyer but "fail to deliver." This form is called naked short selling.
Can you borrow shares for short selling? ›
Short selling involves borrowing a security whose price you think is going to fall and then selling it on the open market. You then buy the same stock back later, hopefully for a lower price than you initially sold it for, return the borrowed stock to your broker, and pocket the difference.
What are the benefits of short sellers? ›
Short selling is a regulated and widely used strategy. Investors use short selling when they believe, based on fundamental research, that a stock price is overvalued. Short selling promotes liquidity, stabilizes markets, and helps investors and companies reduce risk in their portfolios.
How long can you borrow shares to short sell? ›
There is no mandated limit to how long a short position may be held.
