The best short seller cost control comes from playing the right stock at the right time! Timing is the cost control secret of short sellers that keep costs of fees, commissions, other carrying charges plus dividend expenses as low as possible. By getting that done while lining up prices with volumes on quality target stocks, short sellers produce profits.
How do short sellers control costs?
Short Story Shorting Stocks course, Lesson 8, answers the question, how do short sellers control costs? At the end of the lesson, links to related content help you learn more.
What you learn:
The lesson makes you aware that short sellers must get and do many things right including controlling fee, commission, carrying or dividend costs timed with share price movements and volumes. Knowing that informs you how important parts of stock markets function.
Short sellers need the right costs and prices
All costs and share prices matter when selling short and include transaction costs and fees, selling share price realized and finally the share price when buying to close out the short position.
Time control is the best cost control
Controlling the timing of their short play is the biggest cost control that short sellers have. Most short plays conclude in more than a few days or a week but most often under a month. There are epic exceptions such as when giant hedge funds tackle a large player they think is overvalued, mismanaged or conducting some illegal or questionable business.
Carried on long enough those titanic battles can make the mainstream news or it seems at lease the business entertainment pages. These are wars that few investors want to go anywhere near. Staying away is you best cost control!
Costs, all costs
Someone new to short selling soon feels they carry a sign that says, “I sell short, charge me a fee!” It seems everyone has a few fees for any short seller. Borrowing, carrying, transaction, administration, management, commission, a fee for this a fee for that!
Short fees include interest costs or the equivalent, transaction costs and costs of paying any dividends. All costs need to be known and considered. Short selling costs add up each day the short seller carries a borrowed or open stock position.
Remember, the short seller has to find and borrow stock before selling it. Just as the short seller considers the transaction in order to make money, so is everyone else that aids or facilitates the transaction. The short seller pays them all.
Also be aware that should the shorted stock be a dividend payer, all costs associated with paying the dividend, and the dividend itself, comes from the short seller. Remember, the short seller sells stock they do not own. So should any dividends that are due while the short position remains open, the short seller must pay.
Dividends can take a big bite.
And there is no opportunity to later recover the sunk cost of paying any dividends. The dividend paid by the company being shorted goes to the owner of the shares that are sold by the short seller.
Those are borrowed shares, so the short seller must pay the dividend to the account that the shares were borrowed from. The short seller stands on their own. They pay all costs.
Dividends are one factor that can become a very significant cost to a short seller. This is especially true if the timing the short selling is significantly off. Worse yet, if multiple dividend payments are needed.
Recall, the brokers-loaned stock that was borrowed from another account. The owner of that stock still has the right to, expects, and gets, their dividend payments without any interruption or risk.
The cost of those dividend payments immediately comes directly from the account of the short seller on the due date. In cases when the account has insufficient cash, it forces the sale of other assets or any unrelated shares in order to produce the cash.
Share Prices
The share price, both when short selling to open the position and when buying back the shares to close the position, must be in the short seller’s favor, to make a profit. Before opening the position, the shares of the target company must be trading at prices significantly above what the short seller believes is the real or true value of the shares.
The short seller needs a buyer for what they believe to be an overvalued stock. That means any viable short candidates must have relatively high ‘overvalued’ stock prices.
In practical terms the potential for both substantial and downward price movement must be in place. That means never considering low-priced stocks as potential shorts. Even when bad news can drop such a stock price considerably lower.
Obviously, if the market knows or anticipates bad news, the price will already be discounted. In such circumstances, the price has limited further downside potential. That makes such a stock an unattractive short target. The wise short seller would move on and look for a short target that offers greater short profit potential.
Volume
There has to be a significant and continuing volume of shares being exchanged for any potential short target to be attractive. Never short a low volume stock. When selling the high priced shares to open the position and when buying back lower priced shares to close the position, the volume must be there.
Should volume dry up at either end of the short sale transaction, there is an immediate and big pricing/cost problem. Forcing either transaction by chasing the market down to sell, or up to buy and close the position, can quickly devour any profits. In worst case scenarios, profit quickly turns to unlimited running losses.
Should the short seller be wrong about cost or price factor, the transaction can become an unlimited financial horror story and money loser. Buying back the stock and repaying the loan provides the only way out.
The cost of size
Ironically shares of big companies with large trading volumes are usually, “Easy to Borrow”, sell and buy back to cover, all a relatively low associated costs. Smaller companies or those with lower trading volumes are inevitably, “Hard to Borrow” at higher cost, carry more margin risk and often don’t work particularly well as profit making shorts.
The lesson is to stay in the current because the market in the shallows may leave you stuck on the shoals of high costs and no profit. Or worse, meting out financial torture as an ugly short squeeze in a thinly traded stock. Painful reminder, do not short here!
The short squeeze
The short squeeze is the worst case that occurs when the short seller miscalculates and the share price does not drop, but rises instead. Those short plays are on the wrong side making the wrong move. Prices that run against shorts can quickly build upward momentum.
The stock price can significantly and rapidly rise as it moves against the short seller. Dividend costs just add to the financial pain. Should traders know, realize or believe a large short position is wrong or ‘off-side’, a buying frenzy can be unleashed! It can get ugly. But like watching a car crash, it is hard to look away!
Opportunistic traders can quickly descend like sharks on wounded prey knowing that the short must add more buying to cover their short position. The short cover buying, ironically, adds to their own financial pain! That short covering buying pressure can push prices higher yet.
Price escalation can ruin a short play
Dramatic and rapid escalation in share prices can occur. That can force a short seller to cover to stop their losses. In one of the bizarre facts of market life, their buying adds to their financial pain. Their buying only pushes the prices higher yet.
When short sellers are trying to close a short position and stock prices are rising, the short seller is experiencing the pain of a short squeeze. The classic short squeeze is not pretty for the short seller but party time for the long investors!
Company management can declare victory and say the good guys won as they do some gloating. Few tears get shed for short sellers that lose their bets.
Be careful out there
About all shorts can do for cost control is to get the play right and execute with flawless timing. Without being reasonably correct about timing, a significant price drop and trading volumes, short selling transactions can be very expensive and financially unpleasant exercises.
Get it all right and taking a short position can quickly produce dramatic and considerable profits. As I have said before, short selling is not a strategy for a beginner. Don’t learn about investing by taking any short positions under any circumstances.
Question Answered!
For cost control, short sellers have limited choices but have to select the right target, at the right time and execute with skill to profits. Missing on any of those gets financially ugly! The lesson makes you aware that short sellers must get many things right including controlling fee, commission, carrying or dividend costs timed with share price movements and volumes. Knowing that informs you how important parts of stock markets function.
Lesson takeaways,
Short seller cost control, includes:
The best short seller cost control comes from playing the right stock at the right time! Timing is the cost control secret of short sellers that keep costs of fees, commissions, other carrying charges or dividend expenses as low as possible. Get that done and line up prices with volumes to produce a short selling profit.
- Cost control requires selecting the right target.
- The timing of the short play must be right for the lowest costs.
- Entry and exit execution must be flawless for the lowest costs.
- All costs pile up including fees, commissions and transaction costs.
- Dividend costs can add significantly to a short selling expenses.
- Share price movement must cooperate to make short selling viable.
- Short operations need good volumes of shares to avoid thin trades.
- Short squeezes are an expensive risk to short sellers.
- Buy-in costs are a constant short selling risk.
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Short story shorting stocks:
Short selling stock explained Lesson 1
Short selling improves markets Lesson 2
Short selling improves companies Lesson 3
9 Short seller facts align Lesson 4
Making money selling short Lesson 5
Shorting stocks has risks Lesson 6
Who’s selling your stock? Lesson 7
Short seller skill sophistication knowledge Lesson 8
Short seller cost control Lesson 9
Short selling has rules Lesson 10
Next lesson 10:
Short selling has rules
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