Risks of Shorting Stock
There are special risks associated with shorting stock in a margin account that expose the investor to potentially significant losses. Therefore, this type of strategy may not be suitable for all customers. Please read the following carefully:
- Unlimited Risk. Shorting stock can be a risky strategy for investors. There is unlimited risk (loss) to the upside when shorting stock and limited reward (gain) if the stock falls to zero.
- Hard-to-Borrow Fees May Be Charged. If a customer is short a stock, the clearing firm has to borrow it in order to deliver it to the buyer. When there is huge demand to short a stock, and a shortage of shares available to borrow, holders of long stock can charge very high rates to borrow stock. These rates are classified as hard-to-borrow rates and occur when the customer initially shorts a stock or while the stock is being held short by the customer. In either scenario, a customer most likely will incur hard-to-borrow fees without prior notice. These fees are at a market rate and charged by OptionsHouse’s clearing firm, Apex Clearing Corporation, on a daily basis. Recently, the market has seen stocks such as General Motors (GM) and Citigroup (C) have hard-to-borrow rates in excess of -100% annualized. Most cases involve much lower rates, but a customer needs to closely monitor their hard-to-borrow fees to ensure they still believe shorting the stock is worthwhile.
- Buy-In Risk. If a customer is short a stock, and there is a shortage of shares available to borrow, the customer may be at risk for a buy-in of the stock, which can happen without warning.
- Margin Risk. Shorting stock is suitable only for the knowledgeable investor who understands the risks, has the financial capacity and wherewithal to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements. In this regard, if the value of the stock increases, OptionsHouse may request significant additional margin payments. If an investor does not make such margin payments, OptionsHouse may liquidate stock or options positions in the investor’s account, with little or no prior notice, in accordance with the investor’s margin agreement. In addition, an investor in this situation is not entitled to an extension of time on a margin call. Further, an investor can lose more funds than deposited into a margin account.
A cash account may not short stock, and therefore, these risks are not applicable.