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Thinking about the current situation where GME has been shorted by more than the existing float, I think I have a basic understanding of short selling as selling shares you've borrowed. I've seen a number of reasons proposed for why the holders of these short shares may be forced to cover their shorts, but I've also seen each of these reasons called out for not being true. Here are the four reasons I've seen, as well as the counters:

  1. They pay nightly interest.

Counter: The interest rate is low, and much less than covering would cost.

  1. They must put up large sums of money as margin calls.

Counter: This is temporary, and better than the cost to cover.

  1. There is an expiration date, by which they must cover.

Counter: This applies to put options, but not to short sales.

  1. The loaner of the short shares can demand it back.

Counter: This is either not true, or not likely in this case

So which, if any, of these is actually true, (and conversely, which, if any, of the counters is not true)? Is it the combination of multiple ones?

  1. Are there other reasons why they can't hold their positions that I haven't listed here?

Or is it the case that they can in fact hold their positions as long as they're confidant the price will drop a lot, and that there is just a temporary cost of maintaining?

EDIT: I understand there is no guarantee that the price will go back down. However, for the sake of this question let's assume that at the very least the short sellers are confident that the price will be significantly lower (a tenth) in a couple months, than it is now. They desire to simply wait for that, can they do that, regardless of if they are wrong?

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  • Note that it's possible for the price to go up more and more, resulting in more and more margin calls. Today's margin call may be cheaper than closing out (in fact that should be true on all days) but closing out today might be cheaper than next week's margin call. – user253751 Jan 29 at 21:21
  • Why donate your car this week when you can give them your house next week? ;->) – Bob Baerker Jan 29 at 22:02
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You're conflating several issues and assuming that one is better than the other. OK, one by one:

  1. The daily interest cost is the borrow rate times the price of the stock. Perhaps yesterday, GME's borrow rate was 40%. At today's close of $325, that's $35.62 per day which projects to $13k per year. Note that the borrow rate and security price vary so the $13k projection is just to reflect what holding a long term short position could look like.

This has nothing to do with much less than covering would cost. Covering is a decision to either book gains or limit further losses.

A 40% borrow rate is high for normal situations but surprisingly low for what has been going on with GME. I recall Tilray being over 900%.

  1. They must put up large sums of money as margin calls.

THIS IS THE BIG PROBLEM. Per Reg T, shorting requires 50% initial margin and the margin maintenance requirement (MMR) is 30% (brokers can require more).

I'll spare you the intricate details of the math but if you short on 50% margin with a 30% MMR, you have about 15% buffer until you need to provide more margin. For example, short 100 shares at $20. A bit above $23, you'll need to add more margin. After that, for every $1 that the stock rises, you'll need another $130 of margin in your account. If not, your broker will close your position. If GME goes to $400, along the way you'll have to have added a bit over $49k to your account on the way up in order to remain short 100 shares at $20. OUCH

  1. There is no expiration date with short selling equities.

  2. The loaner of the loaned shares only demands them back if the owner sells them and his broker cannot find replacement shares. Otherwise, you can remain short as long as you want to, assuming that you are solvent (see the $49k above).

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  • Is the interest rate a daily one or annual one? Articles like this one say it's an annual rate that you divide by 365 to get the daily rate. That is a pretty big difference. questrade-support.secure.force.com/mylearning/view/h/Investing/… – DaleSwanson Jan 29 at 23:08
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    But your $35.62 per day is for a 100-share position (you didn't explicitly state this). – nanoman Jan 29 at 23:52
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    @JTP - Apologise to Monica - It's not a problem. Given that I've had comments deleted before, I doubt that this is the first flag that I've received. It seemed rather silly to me that for anyone who understands the market, figuring out that the answer involved 100 shares would be obvious. IOW, like you, do I have to explain what 14 minus 6 is ? I thought not. :->) – Bob Baerker Jan 30 at 13:13
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    I wasn't the flagger. But to give my perspective: The main purpose of comments is to improve answers; and the main audience for your answer is not someone who "understands the market", but someone who is learning. Already knowing how borrow cost works, I was able to infer 100 shares. But it would still be better to spell it out, since your example should help clarify how it works. ... – nanoman Jan 30 at 18:07
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    ... I do think it's a bit of "gee-whiz" when you say "$35.62 per day...$13k per year" without putting it in context with the size of underlying position you're talking about (in this case, $32.5k). In most elementary discussions of stocks, amounts are quoted per share, not per 100 shares. And while you and I know the borrow rate is quoted per year, it was confusing enough to get a follow-up from OP. – nanoman Jan 30 at 18:08
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Your question assumes that eventually "the price goes back to normal". There is no guarantee that will happen. Short sellers have experienced large losses but also an increase in the risk of further losses, as the stock has become extremely volatile.

What was originally a $1 million short position, for example, may have become a $20 million short position that is now extremely leveraged (since the short seller's portfolio equity has declined while their exposure has increased).

Volatility can go in either direction, and leveraged losses are particularly destructive. So covering shorts may be a matter of surviving, versus continuing to put up more money for margin until going broke.

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