Do any brokers pay interest on the proceeds of short sales? All my discount brokers sit on the money without paying interest, which doesn't seem particularly fair. -- Doug Moore
Equality for retail investors hasn't set in when it comes to short-selling.
If you have millions of dollars to trade, you may be able to get some of this interest from a broker, but the average individual investor is going to get naught.
First, here's a quick explanation for the uninitiated: In a standard securities transaction, you buy a stock with the belief that you think that it's going to go up. That's a long position. Conversely, a short sale is a way that an investor can bet that a stock is going to go down.
In a short sale, the investor borrows securities from a broker and sells them into the market with the understanding that the stock will be bought back at a later date and returned to the broker. If the stock goes down, the investor is buying it back at a cheaper price and will make money on the trade. If it goes up, the investor loses.
Once the borrowed securities are sold into the market, the cash from that sale is obviously earning interest somewhere. But retail customers typically don't see any of that extra money.
Why not? Because the broker doesn't have to give it to you. I'll put it this way: Brokers don't make money on commissions alone.
Once again, large investors have the advantage over the little guy and can negotiate to get some of this money back. It's called a short-interest rebate. Simply, the biggest clients with the biggest balances will get the biggest rebates.
Even though you might see a balance in your brokerage account after shorting a stock, you're actually looking at a false credit, according to one big brokerage firm. That money is acting as collateral for the short position. So, you won't have use of these funds for investment purposes and won't earn interest on it.
And there are indeed costs associated with shorting a stock. The broker has to find stock to loan to you. That might come out of a broker's own inventory or might be borrowed from another stock lender.
However, some stocks are more difficult to borrow than others. (Actually some securities may not be available for shorting, particularly smaller stocks.) If a stock is hard to borrow, you may end up getting charged for that privilege.
And there are operational and administrative costs associated with a short sale. These transactions are certainly more difficult to track than long positions, given the fact that they involve borrowed securities and collateral requirements.
Given the amount of money the brokerage firm might make on a small transaction of this type, it won't make economic sense to give you a short-interest rebate, according to industry professionals. This is a business, they say, and the goal of these firms is to make money.
But if you are really worked up about the issue, you can always ask for some of the interest. Just don't hold your breath.
If you've got a $20 million short position, that will undoubtedly give you some bargaining leverage.
I didn't hear back from all the brokerage firms that I called, but of those that did get back to me, I didn't find one that says it gives retail customers interest on the proceeds of a short sale.
For example, Frank Lawatsch, general counsel at
National Discount Brokers
, says, "
, our clearing broker, charges us, and we charge the customer. As an economic matter, it costs you more to short."
It's certainly possible that I've missed one. Let me hear from some retail short-sellers out there. If your broker gives you a short-interest rebate, tell me. Email me at
email@example.com, and please include your full name.
A Perilous Proposition
I don't want to sound like a fear-peddler, but I caution individual investors from getting into short-selling. Unless you have some specific information about an industry or some very special insight into a company, you should stay away. With a short sale, you have a limited upside -- the stock can only fall as far as zero -- and an unlimited downside -- it can theoretically rise forever.
If you don't know what you are doing in a short sale, you could be in for a world of pain.
Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.