Risks of Short Selling

Market Risk

Short sellers attempt to profit from a decline in the price of an instrument. The short seller sells shares they do not own and hope to buy the shares back at a lower price. However, the price of the instrument may increase. Since there is no limit to how high an instrument’s price can rise, the short seller’s potential losses are unlimited.

Borrow Fees

In order to sell short, we must expect to have shares available to lend you on settlement day, or expect to be able to borrow shares on your behalf on or prior to settlement day, in order to settle your trade. IBKR's trading platforms display share availability and stock borrow fees in real-time. These rates are indicative and are subject to change intra-day due to supply/demand and other market conditions. In certain cases, “Easy-to-Borrow” names which have previously accrued low borrow fees (for example, Russell 2000 Index members) may become “special” in the securities lending market, leading to the short position holder being charged higher borrow fee rates.

Borrow Fees Can Increase Due to Corporate Action

Certain corporate actions including (but not limited to) mergers, tender offers, and distributions can lead to spikes in borrow fees.

Announced dividends frequently lead to decreased supply and therefore higher borrow fees in the days leading up to record date. When a company issues a dividend distribution to its holders of record, a borrower of the shares as of that date is listed as the holder and therefore receives the dividend. If the borrower sold the shares short, the buyer would receive the dividend. The dividend is then “claimed” by the lender from the borrower, and credited to the lender as a Payment-in-Lieu, or “PIL.” PILs are not considered by the IRS to be qualified dividends, so the lender may incur adverse tax consequences as a result of receiving a PIL instead of a qualified dividend. As lenders recall their shares to avoid this possibility, the number of loanable shares across the market decreases, which can lead to a surge in the borrow fee rate.

The short seller may also be subject to compensating the lender for potential tax consequences of receiving PIL, while shares were on-loan, instead of a dividend directly from the issuer. Compensation will be reflected in a higher borrow fee rate paid by the short seller on the dividend’s record date. This is called a “Gross-Up.”

Note that an adjustment to the borrow fee rate may be processed after the record date but “as of” the record date.

Borrow Fees Can Increase Due to a Change In Collateral Value

The borrow fee amount that short sellers pay is based on the collateral value of the stock they borrowed. Detailed examples can be seen on the Short Sale Cost page. Collateral value is marked-to-market daily. If the collateral value increases, you will pay a higher amount in borrow fees even if the borrow fee rate remains the same.

Borrow Fees Can Increase Between Trade Date and Settlement Date

Before a client’s short sale order can be executed, the Securities Lending Desk locates the shares needed to fulfill the seller’s delivery obligation to the buyer and displays an indicative rate on IBKR platforms throughout the day.

However, brokers do not generally borrow the securities until the settlement date (when delivery to the buyer should be made), which is one (1) business day after trade date (T+1). There is a risk that the borrow fee increases between the time of short sale execution and settlement date. You will be charged the borrow fee rate as it exists on the settlement date, as that is when shares are actually borrowed, thereby possibly accruing higher borrow fees unexpectedly.

Corporate Action Liability

Short position holders are held liable to the long holder for distributions made by the company including (but not limited to) dividends (regular cash, special cash, shares), rights/warrants, and spin-off’s, mergers and tender offers. This means that you could be liable for a substantial payment or take on significant additional economic exposure.

De-listing and Trading Halts

When a company is delisted from the public markets or trading in that stock is halted by the listing exchange, traders may be unable to cover their short positions because the stock no longer trades. However, the original loan to the borrower is still on record.

Short positions in delisted stocks can be removed only after shares are cancelled and the Depository Trust Company (DTC) removes all positions in the shares from participants' accounts. That process can take anywhere from a few days to months or even longer, particularly if the company is engaged in a Chapter 7 bankruptcy proceeding.

Short positions in a stock that is halted can only be closed after the halt is lifted. While most halted securities remain so for a short time, a stock can be halted indefinitely.

In the meantime, the borrower continues paying borrow fees on the collateral market value based on the closing price of the last trading day. The minimum collateral mark is $1 per share but can be much higher, depending on how and when the delisting or trading halt occurred.

Buy-in Risk

In certain situations, IBKR will buy in (or "close out") a short position without being directed by the position holder. We strive to avoid buy-in’s where possible, within the limits of its regulatory obligations. Please see the article “Overview of Short Stock Buy-Ins & Close-Outs” for more details.

Leveraged ETF and ETN

Leveraged Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN) have characteristics which may increase the likelihood of buy-in events occurring. The supply of shares available to borrow is influenced by a number of factors not found with shares of common stock. An overview of these factors can be found in “Special Risks Associated with ETN & Leveraged ETF Short Sales”.

Short Positions Resulting from Options

Holders of short call options can be assigned before option expiration. When the long holder of an option enters an early exercise request, the Options Clearing Corporation (OCC) allocates assignments to its members (including our members) at random. The OCC reports assignments to us on the day of the long call exercise (T) but after US market hours. As such, option assignments are reflected in our client accounts on the next business day (T+1), which is also the settlement date. The assignment causes a sale of the underlying stock on T, which can result in a short position if no underlying shares are held beforehand. Settled short position holders are subject to borrow fees, which can be high. Additionally, if we cannot fulfil the short sale delivery obligation due to a lack of securities lending inventory on settlement date, the short position can be subject to a closeout buy-in.

Due to T+1 settlement mechanics described previously, traditional purchases to cover a short position on T+1 will leave the account with a settled short stock position for at least 1 night (or longer in case of a weekend or holiday).

Long in-the-money Puts are automatically exercised on expiration date. A short position as a result of the exercise carries the same risks as assigned short calls.

Example

Assignment of 100 XYZ Call without holding underlying XYZ stock

Day		Short Sale	Buy to Cover	Settled Short Position	Borrow Fee Charged?
Monday	OCC reports short call assignment to IBKR after market hours.	-100 XYZ stock Trade Date (T)		0	No
Tuesday	Call assignment and stock sale are reflected in the account	T+1 Settlement Date	+100 XYZ stock Trade Date (T)	100	Yes
Wednesday			T+1 Settlement Date	0	No