Short selling
Overview
Usually when you invest in shares you want to ‘buy low and sell high’. Naturally, you buy shares you think are going to go up in price. This is known as buying long, as any profits will be delivered down the track. Short sellers do the opposite - they want to gain from a fall in price, so they're looking for shares they think will go down.
Unlike other share traders, short sellers do not 'own' the shares they sell. They sell them hoping that the price will fall before they have to hand over shares in settlement of the sale. That's how profits are made.
For example, there's a share on the ASX valued at $5. The short seller thinks the price of this share will go down, so the short seller goes onto the ASX and enters into a contract to sell that share. In order to settle the sale, the short seller might then buy a share in the same company and use that newly bought share to fulfil the contract.
- If the short seller ends up buying the share at $3.00, the short seller makes a $2.00 gain. This is because the short seller had agreed to sell the share at $5.00.
- But if the short seller has to buy the share at $7.00 in order to fulfil the sale contract, the short seller makes a loss of $2.00.
Short selling is a common practice for institutional investors and is sometimes used as a hedging device. It can also play an important role in the efficiency of markets.
Short sales can be either ‘naked’ (also referred to as ‘uncovered’) or ‘covered’.
| Naked short selling is effectively banned in Australia, with some exceptions. Naked short selling refers to when the short seller does not own the stock and doesn't have in place a prior arrangement to deliver the stock that will settle the sale. |
Covered short selling
A ‘covered’ short sale is when the short seller does not 'own' but has, at the time of sale, borrowed the particular stock from another person (the ‘stock lender’) and uses the borrowed stock to settle the sale. The short seller buys similar stock to repay the stock lender. This is less risky than the banned practice of naked short selling from a settlement perspective, because the short seller has a binding stock lending agreement for the specific stock in place. That ensures they will have stock to deliver on settlement. These types of short sales need to be disclosed.
How does stock lending relate to short selling?
In ‘stock lending’, stock is transferred temporarily from one party (the ‘lender’) to another (the ‘borrower’), with the borrower obliged to return equivalent stock at the end of an agreed term, or on demand. In Australia, stock lending agreements are typically made using an Australian Master Securities Lending Agreement. Under the terms of that standard agreement, the borrower actually acquires title to the stock. There are many reasons why someone may choose to borrow or lend stock. One reason why a person may borrow stock is so they can ‘cover’ a short sale.
Media releases
ASIC's media releases have more information on our recent actions relating to short selling:
09-94 ASIC lifts ban on covered short selling of financial securities
MR09-36 ASIC extends ban on covered short selling of financial securities
09-05 ASIC extends ban on covered short selling of financial securities
AD08-65 ASIC lifts ban on covered short selling for non-financial securities
AD08-44 Short selling relief for convertible securities expanded
08-210 ASIC extends ban on covered short selling
08-205 Covered short selling not permitted
08-204 Naked short selling not permitted and covered short selling to be disclosed
More information
More on investing in shares
Complex investments
FIDO Website: Printed 02/10/2010
