Sunday, December 16, 2007

Short-selling Part 2 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
We start with the SBL account, an abbreviation for Shares Borrowing and Lending. This is the traditional method for short-selling, whereby one borrows from a pool of ready-for-lending securities in order to sell short. This enables the trader to hold longer than if he were doing "naked" short-selling, where he basically just sells the stock short without borrowing scrip. In naked short-selling, one has to cover within the same day or else SGX will do it for him over T+3 period, at unknown prices. The trader with the SBL account has the luxury of holding his short position, albeit curtailed in some ways (will be explained shortly).

SGX does facilitate SBL accounts by providing a ready pool of various companies' stocks for lending to interested parties. The list can be found in the CDP website. Traders cannot borrow directly, but have to do it through brokers, who probably earn a spread of >3% by borrowing these shares at 4% and then re-lending it to their clients at 7-10% varying.

I assume that readers will be familiar with the idea of margin in short-selling, which is basically putting up a certain amount of equity (own money) to assume (long or short) positions in a stock, that equals about 30-50% of total assets (stocks + cash). This is inherent in short-selling, where one is essentially borrowing the scrip. One way to think about this is that the trader is taking up broker's loans to finance the scrip borrowing, and his margin money serves as additional collateral so that should things go bad, the broker will not run into bad debt problems. And of course there is the margin call, which is basically when share prices do go counter to the trader's hopes, in which case he has to top up the margin. The problem in Singapore is that typically he has to top up margin within T+2, while sales of his stock will only yield payment at T+4. Hence it is impossible to react to margin cash call by selling one's other stocks on the same day.

It is interesting to observe what attitudes some brokers have towards short-selling. Some brokers are simply ignorant about it. Some are quite guarded eg. DBS Vickers and DMG Securities said "We do not encourage short-selling." and that was that. The local ones that offer SBL would be Kim Eng, Phillip and iOCBC. I wonder why the former two do not, since it is really lucrative. See below.

The key costs and possible complications are both open and hidden. The commissions and charges are disclosed openly. The key one to watch out for is borrowing interest. This is the interest on broker's loans used to acquire the scrip, and it is exorbitant. One can be borrowing at rates from 7-10%/annum, as mentioned above, to take up short positions, and that is calculated based on total value of shares borrowed regardless of what he puts up as margin. Hence, even if the trader is not aggressive and puts up a lot of margin, the financing charges are still the same. If one was operating on the long (ie. buy) side, this charge is non-existent (if he does not borrow). Thus the only charge for the long trader is 0.3% commission. The Internet SBL short-seller pays that commission as well, and 7-10%/annum interest on top of that. Supposing one assumes an SBL short position on $100k worth of shares over three months, the financing interest will be $2500 (based on 10% financing interest) plus $600 round-trip trading commission, 5 times that of a long position which incurs only round-trip commission. And that ratio further rises if the short is held over a longer period. It is expensive to short.

The other main thing to note is the issue of scrip recall. Note that the lender has the right to recall the scrip within a T+4 period should he wish to sell the stock. Consider the following two scenarios:
(1) Stock rises, rightful owner (lender) decides to sell to take profit. SBL short-seller has to return shares and cover, sustaining losses. He then has to look for other scrip to borrow.
(2) Stock falls, rightful owner (lender) decides to sell to cut loss. SBL short-seller has to return shares. Although he makes gains, he cannot ride further on the downward momentum of the market unless he finds other scrip to borrow.

This means that the shares might well be recalled at the most inopportune time to the SBL short-seller.

There are also other miscellaneous issues like the payment of dividends, the issue of stock splits which can be pretty confusing and complicated. All this conspires to put pressure on the short-seller and inculcate a sense of siege mentality within him/her. The next article covers CFDs which ameliorate some of the abovementioned problems but also have some problems of their own.




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