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Shorting

Selling Short | SEC & FINRA Rules | Shorting Opportunities

Selling Short

Selling short is a strategy for making profits on the decline of an individual stock. The short-selling investor initially borrows stock from the broker/dealer, then sells the stock into the market. The trader anticipates that the price of the stock will go down enough to allow him to replace the borrowed stock at a lower price at a later date. The seller is obligated to buy the stock and replace the borrowed shares in order to close the short position. If the price does decline, cheap stock is bought to cover the short sale and close out the position at a profit.

Profit is realized when the security is re-purchased (buy to cover) at a lower price. However, this strategy exposes an investor to an unlimited loss should the security rise in price.

TO ILLUSTRATE:

The Good:

The market price of ABC is $100. Trader Jim sold short 100 shares at $100. As the market price of ABC falls Trader Jim has an unrealized gain in the amount equal to the selling price less the market price. When ABC reaches the market price of $90, Trader Jim buys back to cover. He then realizes a $1000 profit. (100 X ($100-$90))

The Bad and the Ugly:

If Trader Jim sold short at $100 and the market price then rose 15 points, Jim would be facing a $1,500 loss. Beware, the loss potential is only limited to how high the price of the security could climb, in theory this loss is unlimited.

SEC & FINRA Rules

UP TICK RULE

To prevent short sell transactions from causing a precipitous fall in a securities market value, the SEC and FINRA have established specific rules for shorting securities. The first rule is the Uptick rule for listed securities. The Uptick rule requires that short sales of NYSE securities be effected only at a price above the previous sale price (an uptick) or at a zero plus-tick. A zero plus-tick occurs when a tick is equal to the preceding tick, but is greater than the most recent different tick.

On a NNM or NASDAQ National Market security the parallel rule is called the Bid Rule. To effect a legal short sale on a down bid, the sale must be executed at a price at least 1/16 of a point above the current inside bid if the spread is 1/16 point or greater; or at a price equal to or greater than the offer price if the inside spread is less than 1/16 point. On the level II, an up bid is denoted when the bid is highlighted in green and a down bid is denoted in red. If the inside bid is green the stock is shortable.

The rationale for these rules is to prevent an uncontrolled decline in the market price of the security based upon short selling of the security, since the price of a security is ultimately determined by the number of sellers vs buyers. If there are more sellers the market price will continue to decline and the traders who shorted the stock will in effect be manipulating the market for profit. The up-tick restriction requires a buy to offset a short sell to prevent artificial selling pressure in the security.

REGULATION T RULE

Additionally, a short sell is treated as an opening position and is subject to Regulation T. Regulation T or Reg-T is the margin rule that requires an initial deposit equal to the value of 50% of the sell price plus 100% of the proceeds. The maintenance requirement is as follows: 100% of the proceeds of the sell plus 30% of the closing value of the security. The account is marked to market at the end of each trading day. It important to note Reg-T is only applied to the initial purchase. If the Reg-T amount is not in your account on the day the purchase was made it will cause a Fed call.

$5 DOLLAR RULE

Additionally, short sells can only be placed on securities with a market above $5 per share and only in a margin account.

TO ILLUSTRATE:

Trader Jim sold short 100 shares of ABC @ $100. His initial margin requirement is $15,000. $10,000 of this amount will come from the proceeds of the sale; however, the remaining $5,000 will come from cash, margin credit, or will increase the debit balance.

Again, maintenance margin rules apply to short sells as follows: Initial purchase proceeds plus 30% of the market value of the stock.

His initial maintenance requirement is $13,000 of which $10,000 is satisfied with the short sell credit. If the value of ABC rises to $120 his requirement increases to $13,600. His maintenance requirement will be the proceeds ($10,000), plus 30% of the market value of the stock. If Trader Jim does not have the additional $600 in maintenance excess he will be in a maintenance call. Should the value of ABC fall to $50 his maintenance requirement would be $11,500.

At the end of each day the position will be marked to market:

if the market value of the security fell a release to maintenance excess will be posted to the account.
if the security rose in value the maintenance excess would diminish.

Shorting Opportunities

Short sells can be used to profit in a falling market. To facilitate your trading Scottsdale Capital Advisors has an extensive list of over 4000 stocks which can be shorted daily. Additionally, we will make available the previous days all time highs to be shorted; furthermore, if there is a stock not represented on the short list a trader support representative will attempt to secure shares for your use. Such requests normally take between 2 to 5 minutes to process and the stock is then shortable.

Scottsdale Capital Advisors can make available 5000 shares of any stock on the list of over 4000 stocks available daily. These shares are offered on a first come first served basis. Upon request we will attempt to obtain additional shares; however, this is on a best efforts basis.

If you would like more information on the fundamentals of short selling please call Trader Support at 1.800.327.1883.