December 9, 2011 | In: General

How Long Can a Stock Be Short?

My simple introduction to shorting stocks has generated some considerable readership since I have published it. It seems that there are more shorter-wannabes than I had initially thought. Now, one of the most common questions that a new investor asks: “How long can a stock be short?”, or in other (more technical) words, “How long can I leave my short position open?”, or, in even more technical words “How long until I have to cover my position?”.

Let me answer this question first and then explain my answers later: Theoretically, a short position can be left open for as long as you want (this means that you can short a stock forever). Realistically, there is a limit set by the borrower (the entity that you have borrowed the shares from and then sold immediately – usually the bank).

Let me now explain… Let’s say you have shorted 1,000 shares of AAPL. Here’s what happens:

  • The borrower (usually the bank/company that your investor account is open with) lends you the shares.
  • You sell the shares immediately in the market.
  • At the current price of $393.35, your account will be credited with about $393,350 (minus the fees). Note that you can never use this money to buy other stocks. This money is locked, as it’s not yours in the first place.
  • And now you wait…

A few weeks later, the stock goes down to $383.35 (which is very unlikely by the way, do not short Apple, at least not right now), which means that you can now cover your position and buy back the AAPL shares that you have borrowed, and then return them to your bank, for a profit of roughly $10,000.

Now, let’s look at another (more likely) scenario. The stock goes up to $433.35 in a month because of the excellent sales that Apple products experienced during the holiday season. Now before you know it, someone from the bank will call you and tell you to “cover your position”, which means that you should buy back the 1,000 AAPL shares that you have borrowed and return them to the bank. This is a loss of $50,000 for you.

When you’re shorting stocks the bank keeps a close eye on your account, if it sees that you are losing a lot of money and that you are nearing a point where you’ll not be able to buy back the stocks, then someone (from the bank) will give you that dreaded call. Oh, and banks are not compassionate at all when it comes to these things (e.g. don’t even think that you can convince them that the stock will fall sooner or later, they won’t buy it).

As I said before, shorting stocks is a very dangerous game and should be avoided if you don’t have confidence that the stock will fall in price soon.

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