What it means
When an investor wants to sell shares they do not own, they must first borrow them from a holder such as a pension fund or a broker. The lender hands over the shares and receives collateral, which is cash or other assets, as security.
In return the borrower pays a fee for the privilege. The fee reflects supply and demand.
Shares that are widely held and easy to find, such as those of very large companies, are cheap to borrow, often costing a small fraction of 1% a year. Shares in short supply, or with heavy bearish demand, can cost many times that and are described as hard to borrow.
The fee is part of the running cost of a short position and is one reason why short sellers need prices to fall by more than the fee in order to profit. The fee is charged for every day the position stays open, so a long-held short position can become expensive.
A very high fee is also a useful signal that many investors expect the price to fall. Lenders benefit by earning extra income on shares that would otherwise sit idle.
In many arrangements, the lender invests the cash collateral and shares the return with the borrower through a rebate, and the fee is effectively built into that arrangement. This is explained further under the related term stock loan rebate.
The fee can change daily, and lenders can recall the shares if they want to sell them. A recall may force the borrower to close the short position at an unwelcome time.
Anyone running a short position should therefore watch both the current fee and the risk of a recall.
In practice
Real-world examples.
Example
A hedge fund shorts a heavily traded technology giant and pays a borrow fee of 0.30% a year. On a $2,000,000 position, that is about $6,000 a year, which is small relative to the potential gain. The fund considers the stock cheap to short.
Example
An investor wants to short a small retailer whose shares are scarce and costs 25% a year to borrow. On a $100,000 position, the fee alone is $25,000 a year. He decides the trade is too expensive unless he expects a very large fall.
Example
A pension fund lends part of its holdings through its custodian and earns a fee on each loan. The extra income reduces its running costs, so members benefit slightly. The fund sets limits on how much it lends and requires collateral worth more than the shares lent.
Formula
Calculation
Stock loan fee = value of shares borrowed x annual fee rate x (days borrowed / 360)
An investor borrows 5,000 shares priced at $40 to sell short. Value borrowed = 5,000 x 40 = $200,000. The annual fee rate is 6%, and the position is held for 30 days. Fee = 200,000 x 0.06 x (30 / 360) = 12,000 x (30 / 360) = $1,000. A 360-day year is used here, though some markets use 365, so check the convention in your agreement.Case study
Seen in the real world.
Tidewater Robotics is an illustrative, fictional listed company with a small free float and a share price of $30. A short seller believes its sales forecasts are too optimistic and borrows 20,000 shares worth $600,000, paying an annual loan fee of 8%.
Over 90 days, the fee costs 600,000 x 0.08 x (90 / 360) = $12,000. When rumours of a takeover bid push demand to borrow the shares, the fee jumps to 40% and the lender recalls part of the loan.
The short seller is forced to close at a loss, and the illustrative lesson is that a loan fee is not a fixed cost. It can move sharply against the borrower, so the real risk of a short position includes borrowing costs and recall, not only the share price.
Watch out
Common mistakes.
- Ignoring the loan fee when judging whether a short position is attractive, when a high fee can wipe out the expected profit.
- Assuming the fee stays the same for the whole life of the trade, when it can change daily with supply and demand.
- Confusing the loan fee with a trading commission, when it is a separate carrying cost charged for every day the shares are borrowed.
Questions
People also ask.
Who receives the stock loan fee?
The lender of the shares receives it, often through a custodian or broker who takes a share, and it is income on shares that would otherwise be idle.
Why do some stocks cost more to borrow than others?
Fees rise when few shares are available to lend and many investors want to sell short, which is common in small or heavily criticised companies.
Can the lender take the shares back?
Yes, most loans are repayable on demand, so the borrower can be recalled and may have to buy shares in the market to return them.
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