Ask Our Pros: Shorts and Bankruptcy

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Reader:

If you're short a stock that files for bankruptcy, what happens to your position? Also, I've been told that if you are short a stock that goes bankrupt, you don't owe any capital gains on it. That didn't seem accurate to me.

-- B.R.

Hal Uy:

If a company files for bankruptcy, the equity is often, but not always, wiped out. (James Altucher actually wrote a fascinating column on trading shares of bankrupt companies after the announcement.)

The only situations where you would not have to cover your short position would be when the stock was halted or cancelled. In the case of WorldCom, the stock was cancelled.

Holding a stock until it is cancelled is very difficult due to buy-ins and the inability to re-short the stock. Regulation SHO has made holding a short until it is cancelled even more difficult.