A short sale occurs when someone borrows a security (or a futures contract) from a broker and sells it, with the understanding that he or she will later buy it back (hopefully at a lower price) and return it to the broker. Investors use short selling (or "selling short") to try to profit from the falling price of a stock.
For example, if an investor believes stock x is overpriced and will fall, he might want to sell short 100 shares of x. His broker will borrow the shares from someone who owns them with the promise that the investor will return them later. The investor immediately sells the borrowed shares at the current market price. If the price drops, he "covers" the short position by buying back the shares, and his broker returns them to the lender.
The profit is the difference between the price at which the stock was sold and the cost to buy it back, minus commissions and expenses for borrowing the stock. If the price goes up, however, the potential for loss is unlimited, because at some point the investor must replace the 100 shares of x he sold.
SEC Vote To Restrict Short Sales Of Stock
On Feb. 24 of 2010, SEC commissioners voted 3-2 to restrict short sales of a company’s stock once it falls 10 percent from the previous day’s closing price. When the 10 percent threshold is triggered, traders could only execute short sales for the stock at a price above the market’s best bid. The curb would be in place through the following day.
Short Sales On Financial Companies Prohibited in UK and US in 2008
On Sept. 18, 2008, the board of the Financial Services Authority (FSA) announced it would introduce new provisions to its Code of Market Conduct to prohibit the active creation or increase of net short positions in publicly quoted financial companies. The goal was to protect the fundamental integrity and quality of markets during disorderly market conditions. The new provisions were implemented at midnight.
One day later, the U.S. Securities and Exchange Commission said it would temporarily ban investors from short selling 799 financial companies. The temporary ban, aimed at helping restore falling stock prices that shattered confidence in the financial markets, took effect immediately.
The SEC ban is set to expire on Oct. 2, but it is expected to be extended past that date.
CBOE Creates Short Sale Update Information In September of 2008, Chicago Board Options Exchange (CBOE) launched a "Short Sale Update" Web Page (http://www.cboe.com/ShortSale) to keep options traders, customers, and CBOE Members fully informed on recently enacted restrictions on short sales. It contains a full compendium of links to lists of the prohibited financial securities, by exchange, and lists relevant SEC and CBOE information documenting the various restrictions. No one source had previously been created to lay out the broad swath of regulatory information on this issue.
Because regulations can and do change, CBOE plans to keep the Web page updated.
- "Short Selling: Nasty, Brutish and Short". The Economist.
- "SEC Curbs Short Selling, Disappointing Goldman Sachs". Bloomberg.
- FSA Statement on Short Positions in Financial Stocks. FSA.
- SEC bans short-selling. CNNMoney.com.
- "Short Sale Ban Chases High-Frequency Traders From the Market". Traders Magazine.