What it means
To sell a share short, a trader must first borrow it from someone who owns it, typically through a broker. The broker looks for shares held by other clients or institutions that are willing to lend them.
If plenty of shares are available, the stock is described as easy to borrow; if supply is scarce, it is hard to borrow. Brokers publish an easy-to-borrow list, often updated daily, to tell clients which stocks can be shorted immediately.
This saves the trader from having to request a locate, which is a confirmation that the shares can be borrowed before the short sale is placed. Rules in many markets require such a locate, and the list is a common way brokers meet that requirement efficiently.
Borrowing is not free. The borrower pays a fee, usually expressed as an annual percentage of the value of the shares, and easy-to-borrow stocks tend to carry low fees.
Hard-to-borrow stocks can have much higher fees, and the borrow can be recalled at short notice, forcing the trader to close the position. The list matters to hedge funds, active traders and anyone using shorts to hedge a long position.
It affects how cheaply and reliably they can express a bearish view, and it can influence market prices because short selling adds to the supply of shares. The size, liquidity and ownership of the company determine whether it is on the list.
A stock can move on and off the list. If many traders short the same company, supply tightens, the borrowing fee rises and the share may be removed.
Because brokers set their own lists and criteria, a stock may be easy to borrow with one firm and hard with another, so traders should always check their own broker's current information. Finance teams meet this idea when they review the costs of hedging programmes or the funding of trading desks.
The cost of borrowing shares is a real expense that reduces returns, and it should be recorded and monitored like any other trading cost. A strategy that looks attractive before borrowing costs can look very different once they are included.
In practice
Real-world examples.
Example
A hedge fund wants to short a large technology company. The shares are on its broker's easy-to-borrow list, so it can place the trade straight away at a low borrowing cost.
Example
A retail investor holds $100,000 of shares in a bank and wants to hedge against a market fall. She shorts an index fund that appears on the list, avoiding the delay of asking the broker for a locate. She sizes the hedge to cover about half of her exposure.
Example
A trader finds that a small biotech company has been removed from the list because of limited supply. He has to request availability manually, and the broker quotes a borrow fee of 15% a year. At that price he decides the trade is no longer worth making.
Formula
Calculation
Borrow cost = Value of shares borrowed x Annual borrow rate x (Days held / 360)
Worked example: a trader shorts 1,000 shares priced at $40, so the value borrowed is $40,000. The annual borrow rate on this easy-to-borrow stock is 1%, and the position is held for 90 days. Assume a 360-day year for simplicity, since brokers' day-count conventions vary.
Borrow cost = $40,000 x 1% x (90 / 360) = $40,000 x 0.01 x 0.25 = $100
On a hard-to-borrow stock with a 25% annual rate, the same position would cost $40,000 x 25% x 0.25 = $2,500, which could erase any expected profit.Case study
Seen in the real world.
Stonebridge Capital is a fictional hedge fund that identified two retailers it believed were overvalued. Retailer A, a large company, was on the easy-to-borrow list at a 0.5% annual fee, while Retailer B, a small company, was hard to borrow at a 20% annual fee.
The fund planned a $2,000,000 short in each for six months. The cost for A would be $2,000,000 x 0.5% x 0.5 = $5,000, while for B it would be $2,000,000 x 20% x 0.5 = $200,000. The expected profit on each trade was about $150,000.
This illustrative case shows why borrowing cost belongs in the analysis. Stonebridge shorted only Retailer A, because the fee on Retailer B would have turned a good idea into a loss.
Watch out
Common mistakes.
- Assuming that a stock on the list will stay on it, when the supply can shrink quickly and the borrow can be recalled.
- Ignoring the borrowing fee, which can be large enough to turn a profitable idea into a loss.
- Believing every broker has the same list, when each firm has its own supply and criteria.
Questions
People also ask.
What is a locate?
It is confirmation from a broker that shares can be borrowed for a short sale, required in many markets before the sale is placed.
Who lends the shares?
Large investors such as pension funds and asset managers lend them through brokers and custodians in return for a fee.
Is short selling risky?
Yes, because losses are theoretically unlimited if the share price rises, so many traders use stop-loss orders and position limits. A trader may also be forced to buy back shares if the lender recalls them.
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