5

In margin trading, you borrow money from a broker to purchase securities. In short selling, you borrow securities to sell them. Still, in both cases, you are borrowing from the broker. Is the only difference between the two the form of the loan (i.e. cash or securities)?

6

Although margin trading and short selling have in common the concept of borrowing something, they are distinct trading concepts with vastly different outcomes and risk profiles — primarily because the former facilitates a buy, and the latter facilitates a short sale.

When you borrow funds from your broker to buy shares, you end up with a long position and you will profit if the share price rises. With a long position, your potential loss is limited, because the shares can only drop as far as zero. Yet, because the funds were borrowed, you can still lose more than the capital you started with.

When you borrow shares to short sell those shares, you end up with a short position and will profit if the share price drops. With a short position, your potential loss is unlimited, because closing your short position will require you to buy back the shares at the prevailing price, which could be anything.

2

The two positions have very different investment results if share price rises or falls. In terms of the loans involved:

In margin trading, you borrow money from a broker to purchase securities.

That is correct and you pay margin interest on the loan.

In short selling, you borrow securities to sell them. Still, in both cases, you are borrowing from the broker. Is the only difference between the two the form of the loan (i.e. cash or securities)?

When you go short, your broker borrows the securities from their owner. Your broker only facilitates the transaction.

When short, you pay a borrow rate which can vary day to day (number of shares times the borrow rate times the closing share price). This goes to the broker (or brokers if two are involved). Some brokers share a portion of the borrow rate with the lending shareowner.

If you are short on the ex-dividend date, you pay the lender the amount of the dividend as payment in-lieu (the lender loses any dividend taxation benefit and the PIL is considered ordinary income).

In terms of margin, the initial margin required is the same for long margin buying and shorting and the margin maintenance requirement is different, 25% for long, 30% for short (unless your broker requires more than Reg T).

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