Editing Short (finance) (section)

== Mechanism ==
{{See also|Securities lending}}
{{More citations needed section|date=January 2019}}

A short seller typically borrows through a [[Brokerage firm|broker]], who is usually holding the securities for another investor who owns the securities; the broker himself seldom purchases the securities to lend to the short seller.<ref name="langasset">{{cite web |url=http://langasset.com/ishort.htm |title=Understanding Short Selling – A Primer |publisher=Langasset.com |access-date=24 May 2012 |archive-date=19 August 2011 |archive-url=https://web.archive.org/web/20110819152246/http://langasset.com/ishort.htm |url-status=dead }}</ref> The lender does not lose the right to sell the securities while they have been lent, as the broker usually holds a large pool of such securities for a number of investors which, as such securities are fungible, can instead be transferred to any buyer. In most market conditions there is a ready supply of securities to be borrowed, held by pension funds, mutual funds and other investors.

=== Shorting stock in the U.S. ===
To sell stocks short in the U.S., the seller must arrange for a broker-dealer to confirm that it can deliver the shorted securities. This is referred to as a ''[[Locate (finance)|locate]]''. Brokers have a variety of means to borrow stocks to facilitate locates and make good on delivery of the shorted security.

The vast majority of stocks borrowed by U.S. brokers come from loans made by the leading custody banks and fund management companies (see list below). Institutions often lend out their shares to earn extra money on their investments. These institutional loans are usually arranged by the custodian who holds the securities for the institution. In an institutional stock loan, the borrower puts up cash collateral, typically 102% of the value of the stock. The cash collateral is then invested by the lender, who often rebates part of the interest to the borrower. The interest that is kept by the lender is the compensation to the lender for the stock loan.

Brokerage firms can also borrow stocks from the accounts of their own customers. Typical margin account agreements give brokerage firms the right to borrow customer shares without notifying the customer. In general, brokerage accounts are only allowed to lend shares from accounts for which customers have ''debit balances'', meaning they have borrowed from the account. SEC Rule 15c3-3 imposes such severe restrictions on the lending of shares from cash accounts or excess margin (fully paid for) shares from margin accounts that most brokerage firms do not bother except in rare circumstances. (These restrictions include that the broker must have the express permission of the customer and provide collateral or a letter of credit.)

Most brokers allow retail customers to borrow shares to short a stock only if one of their own customers has purchased the stock on [[Margin (finance)|margin]]. Brokers go through the "locate" process outside their own firm to obtain borrowed shares from other brokers only for their large institutional customers.

Stock exchanges such as the [[NYSE]] or the [[NASDAQ]] typically report the "short interest" of a stock, which gives the number of shares that have been ''legally'' sold short as a percent of the total [[Float (finance)|float]].  Alternatively, these can also be expressed as the [[short interest ratio]], which is the number of shares ''legally'' sold short as a multiple of the average daily volume. These can be useful tools to spot trends in stock price movements but for them to be reliable, investors must also ascertain the number of shares brought into existence by naked shorters. Speculators are cautioned to remember that for every share that has been shorted (owned by a new owner), a 'shadow owner' exists (i.e., the original owner) who also is part of the universe of owners of that stock, i.e., despite having no voting rights, he has not relinquished his interest and some rights in that stock.

=== Securities lending ===
{{Main|Securities lending}}

When a security is sold, the seller is contractually obliged to deliver it to the buyer. If a seller sells a security short without owning it first, the seller must borrow the security from a third party to fulfill its obligation. Otherwise, the seller ''fails to deliver,'' the transaction does not [[settlement (finance)|settle]], and the seller may be subject to a claim from its [[counterparty]]. Certain large holders of securities, such as a [[custodian bank|custodian]] or [[investment management]] firm, often lend out these securities to gain extra income, a process known as [[securities lending]]. The lender receives a fee for this service. Similarly, retail investors can sometimes make an extra fee when their broker wants to borrow their securities. This is only possible when the investor has full [[title (property)|title]] of the security, so it cannot be used as collateral for [[margin buying]].

=== Sources of short interest data ===
Time delayed short interest data (for ''legally'' shorted shares) is available in a number of countries, including the US, the UK, Hong Kong, and Spain. The number of stocks being shorted on a global basis has increased in recent years for various structural reasons (e.g., the growth of [[130/30]] type strategies, short or bear ETFs). The data is typically delayed; for example, the NASDAQ requires its [[broker-dealer]] member firms to report data on the 15th of each month, and then publishes a compilation eight days later.<ref>NASDAQ. [http://www.nasdaq.com/quotes/short-interest.aspx About the Short Interest Page].</ref>

Some market data providers (like [[Data Explorers]] and SunGard Financial Systems<ref>SunGard's [http://www.sungard.com/financialsystems/products/shortsidecom.aspx ShortSide.com] discusses the product.</ref>) believe that stock lending data provides a good proxy for short interest levels (excluding any naked short interest). SunGard provides daily data on short interest by tracking the proxy variables based on borrowing and lending data it collects.<ref>SunGard. [https://web.archive.org/web/20110916175729/http://www.thefreelibrary.com/SunGard+Launches+Borrow+Indices%3B+First+Proxy+for+Measuring+Short...-a0123159715 SunGard Launches Borrow Indices; First Proxy for Measuring Short Interest on a Daily Basis]. Business Wire.</ref>

=== Short selling terms ===
'''Days to Cover (DTC)''' is the relationship between the number of shares in a given equity that has been ''legally'' short-sold and the number of days of typical trading that it would require to 'cover' all legal short positions outstanding. For example, if there are ten million shares of XYZ Inc. that are currently legally short-sold and the average daily volume of XYZ shares traded each day is one million, it would require ten days of average trading for all legal short positions to be covered (10&nbsp;million / 1 million).

'''Short Interest''' relates the number of shares in a given equity that have been legally shorted divided by the total shares outstanding for the company, usually expressed as a percent. For example, if there are ten million shares of XYZ Inc. that are currently legally short-sold, and the total number of shares issued by the company is one hundred million, the Short Interest is 10% (10&nbsp;million / 100&nbsp;million). If, however, shares are being created through naked short selling, "fails" data must be accessed to assess accurately the true level of short interest.

'''Borrow cost''' is the fee paid to a securities lender for borrowing the stock or other security. The cost of borrowing the stock is usually negligible compared to fees paid and interest accrued on the margin account – in 2002, 91% of stocks could be shorted for less than a 1% fee per annum, generally lower than interest rates earned on the margin account. However, certain stocks become "hard to borrow" as stockholders willing to lend their stock become more difficult to locate. The cost of borrowing these stocks can become significant – in February 2001, the cost to borrow (short) [[Krispy Kreme]] stock reached an annualized 55%, indicating that a short seller would need to pay the lender more than half the price of the stock over the course of the year, essentially as interest for borrowing a stock in limited supply.<ref name="marketForborrowing">{{cite web |url=http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150_advanced_investments/davolio_borrowing_stock_JF.pdf |title=The market for borrowing stock |access-date=25 December 2012 |archive-date=3 June 2013 |archive-url=https://web.archive.org/web/20130603173838/http://faculty.chicagobooth.edu/john.Cochrane/teaching/35150_advanced_investments/davolio_borrowing_stock_JF.pdf |url-status=live }}</ref> This has important implications for derivatives pricing and strategy, for the borrow cost itself can become a significant [[convenience yield]] for holding the stock (similar to additional [[dividend]]) – for instance, [[put–call parity]] relationships are broken and the [[Exercise (options)|early exercise]] feature of American call options on non-dividend paying stocks can become [[Exercise (options)#Exercise Considerations|rational to exercise early]], which otherwise would not be economical.<ref name="hardToBorrow">{{cite web |url=http://www.math.nyu.edu/faculty/avellane/Lecture13Quant.pdf |title=Lecture 13: Hard to Borrow Securities |access-date=25 December 2012 |archive-date=18 May 2013 |archive-url=https://web.archive.org/web/20130518131233/http://www.math.nyu.edu/faculty/avellane/Lecture13Quant.pdf |url-status=live }}</ref>

==== Major lenders ====
* [[State Street Corporation]] (Boston, United States)
* [[Merrill Lynch]] (New Jersey, United States)
* [[JP Morgan Chase]] (New York, United States)
* [[Northern Trust]] (Chicago, United States)
* [[Fortis (finance)|Fortis]] (Amsterdam, Netherlands, now defunct)
* [[ABN AMRO]] (Amsterdam, Netherlands, formerly Fortis)
* [[Citibank]] (New York, United States)
* [[Bank of New York Mellon]] Corporation (New York, United States)
* [[UBS AG]] (Zurich, Switzerland)
* [[Barclays]] (London, United Kingdom)

=== Naked short selling ===
{{Main|Naked short selling}}
A naked short sale occurs when a security is sold short without borrowing the security within a set time (for example, three days in the US.) This means that the buyer of such a short is buying the short-seller's promise to deliver a share, rather than buying the share itself. The short-seller's promise is known as a hypothecated share.

When the holder of the underlying stock receives a dividend, the holder of the hypothecated share would receive an equal [[dividend]] from the short seller.

Naked shorting has been made illegal except where allowed under limited circumstances by [[market maker]]s.  It is detected by the [[Depository Trust & Clearing Corporation]] (in the US) as a "[[failure to deliver]]" or simply "fail."  While many fails are settled in a short time, some have been allowed to linger in the system.

In the US, arranging to borrow a security before a short sale is called a ''locate''.  In 2005, to prevent widespread failure to deliver securities, the [[U.S. Securities and Exchange Commission]] (SEC) put in place [[Regulation SHO]], intended to prevent speculators from selling some stocks short before doing a locate.  More stringent rules were put in place in September 2008, ostensibly to prevent the practice from exacerbating market declines.  These rules were made permanent in 2009.