First up this week is
, who writes, "I have some vague recollection that you can't short stocks that are trading below some low price, like $5 a share or something. I don't recall if that is an exchange rule, an
rule, a brokerage rule or what. I'd like to know the actual rule, the real practice in fact and also whether one is forced to cover an open short position if the stock drops below the threshold."
Ah, such is the lot of the
components these days. The only ones watching the small-caps are the shorts.
Let's start with Regulation T, set by the
Federal Reserve Board
to govern the credit lines brokerages can extend to their clients. Say you want to borrow 1,000 shares from your broker for shorting. Regulation T states that a short-seller must deposit 150% of the borrowed shares' value in your margin account. (All short sales happen in margin accounts.) If 150% sounds a bit excessive, don't worry. Only half the borrowed shares' value comes out of your own pocket; the remainder comes from the proceeds of the shorted stock, which isn't really yours to begin with.
Enter the exchanges. After you've met your initial margin requirement, the NASD and NYSE normally require that your deposit stay above 30% of the shorted stock's market value. But in the case of stocks under $5, the maintenance requirement changes to $2.50 a share or 100% of the total market value, whichever's greater. A stock need only dip below that level for the margin call to come in. Call it risk premium. Note: This is an exchange rule, and your broker may have stricter requirements. Better ask.
Bottom line: If your broker has shares to lend, you can short them, regardless of the price. And if the stock you're shorting drops under five bucks, you don't need to close out the position. Just ante up and steel your nerves.
Next up is
, who wonders why stocks are quoted in those annoying and unwieldy fractions, instead of decimals: Long before there were such things as Federal Reserve notes, much less stock markets, coinage was the only form of currency around. If you wanted smaller denominations, you just chopped them in half, or quarters, or as many pieces as you liked. What the heck, it was still gold.
With the passage of the Mint Act in 1792, the U.S. became the first country in the world to use the decimal system in its currency. Today it's the only country in the world still using fractions in its stock markets. What's going on?
One factor is what economists sometimes call the QWERTY factor, referring to the five letters on the upper left corner of the common typewriter or computer keyboard. It's been common knowledge for decades that the QWERTY layout is less efficient than its rival, the DVORAK layout. But there we go, happily pecking away at a snail's pace. Chalk it up to the law of marginal costs. We have too much invested to make the change worthwhile.
In the case of fractional quoting, market makers have a
invested. Namely, their bread-and-butter, the spread. Many market makers have resisted decimalization from the fear that it would shrink the current minimum 1/16 spread -- that's a profit of 6.25 cents on the dollar -- down to nil. You can't get between a one-cent spread.
Decimalization is going to happen. According to NASD spokesman
, Y2K overhauls may keep the change from happening until late 2000. But U.S. exchanges ultimately will join the rest of the world's exchanges that trade in decimals.
Should you care? Conventional wisdom holds that decimalization is good for investors. Although the exchanges haven't determined what the minimum tick would be in a decimal quoting system, such a system would certainly narrow spreads. But Shokouhi notes that there will be increased costs with a decimal trading system. Quotes will move around more frantically and require updating more frequently, and exchanges and brokers will need better equipment to keep up.
Will the change kill off the market makers? Not likely. Shokouhi says market makers will make up for thinner spreads in increased volume, as exchanges move toward greater trading of foreign securities, and as more investors invest their money in stocks quoted in prices they understand.
A quick memo to
, who wonders what criteria determine which stocks are represented in the new
tracking stock: The Nasdaq 100 represents the 100 largest nonfinancial OTC stocks, with size determined by market-capitalization. Check out a recent
column on the subject.
Memo: Have a dumb question relating to finance? Great. Have a problem with something I've written? That's fine. Send it to
MonEmailbag@thestreet.com, and I'll do my best to answer every Saturday. Include your full name, and please, no questions seeking personal financial advice or regarding personal brokerage disputes. And this reminder: Because of the volume of mail, personal replies can't be guaranteed.