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Suppose I own 100 shares of a company in a margin account. Suppose the brokerage firm lends my shares to a short seller. Questions:

  1. Can I sell my 100 shares while they are still on loan to the short seller?

  2. If yes, what happens to the short seller's position when I sell my 100 shares? Is the short seller's position closed by the stock broker?

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(A) owns the shares and they are loaned to (B) who sells (shorts) them to (C). (A) owns the shares in book entry form but the actual shares are in street name at (C)'s broker.

There are no restrictions on (A). He can sell his shares at any time. When he does that, (A)'s broker requests that (B)'s broker return the shares.

(B)'s broker will then borrow the shares from another in house account that owns them. If no such shares exist, he will borrow them from another broker so that (B) can remain short. If the stock is hard to borrow and none can be found for borrowing, (B) will receive a forced buy-in notice and he will have until 4 PM EST to cover his short position.

It's preferable to work the order yourself when closing the short position. You do not want the broker doing so because his buy-to-close will be done during after hours trading when B/A spreads often widen significantly.

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Investopedia gives the following answer:

If the brokerage firm has taken the shares from its client's account, and that client wishes to sell the stock at some point while the short position is being held, the client can do so without a problem. This sale by the client who was lending shares will usually have no effect on the short seller, as the firm will either borrow the shares from another firm or use other shares in its own inventory.

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    What's going to happen to the short seller if the brokerage firm has difficulty in borrowing other shares to replace the ones I sold? – Flux Jun 26 '20 at 7:13
  • @Flux for stocks with a high liquidity this shouldn't be any issue at all, and therefore these stocks are relatively cheaper to short. For illiquid stocks the broker could in a worse case always buy the stock on the market (this might of course bring some costs, but these might be compensated by the higher costs for shorting illiquid stocks) – Ger Jun 26 '20 at 12:19
  • @Flux - If the brokerage firm cannot find replacement shares then typically, the shorter will receive a forced buy in notice, giving until 4 PM EST to cover (broker policy may vary). It's better to work the trade yourself otherwise the broker will close the short position during after hours when bid/ask spreads tend to be wider, costing you more. – Bob Baerker Jun 28 '20 at 9:27

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