Shorting: What if you can't find lenders?

Question

I understand the shorting means you borrow the shares and sell them first, and pay them back later. So this is two-step process and things can go wrong in each step. For example:

• What if you can't find anyone willing to lend you the shares to short? Does it happen often? In real world, do we know actually know the individual/institutions we are borrowing shares from?
• What if after you sell the stocks, there aren't any stocks for you to buy back? Then you end up owing shares to your borrowers? Will this happen in real life?
• I guess there must be some kinds of public ledger that keeps track of who borrows shares from whom. And there are also mechanisms to enforce the borrower must pay back. Otherwise, people can simply run away. I'm curious to know about how those enforcement mechanisms work.

Answer 1

• If you can't find anyone to lend you the shares, then you can't short. You can attempt to raise the interest rate at which you will borrow at, in order to entice others to lend you their shares. In practice, broadcasting this information is pretty convoluted.

• If there aren't any stocks for you to buy back, then you have to buy back at a higher price. As in, place a limit buy order higher and higher until someone decides to sell to you. This affects your profit.

• Regarding the public ledger: This functions different in different markets. United States stock markets have an evolving body of regulations to alleviate the exact concerns you detailed, but Canada's or Dubai's stock markets would have different provisions. You make the assumption that it is an efficient process, but it is not and it is indeed ripe for abuse. In US stocks, the public ledger has a 3 business day delay between showing change of ownership. Many times brokers and clearing firms and other market participants allow a customer to go short with fake shares, with the idea that they will find real shares within the 3 business day time period to cover the position. During the time period that there is no real shares hitting the market, this is called a "naked short". The only legal system that attempts to deter this practice is the "fail to deliver" (FTD) list. If someone fails to deliver, that means there is a short position active with fake shares for which no real shares have been borrowed against. Too many FTD's allow for a short selling restriction to be placed, meaning nobody else can be short, and existing short sellers may be forced to cover.

Answer 2

Your question has 6 questions marks along with comments on what you'd like to know.

Yes, there are stocks that are tough to short, a combination of low float, high current short positions, etc. Interest charged on the position rises in a supply/demand fashion.

To unwind the position, there's always going to be stock available to buy. A shortage of willing sellers will cause the price to go up, but you'll see a bid/ask and the market will clear, i.e. The buy order fills.

Answer 3

You at least have some understanding of the pitfalls of shorting. You might not be able to borrow stock. You might not be able to buy it back when the time comes. You're moves are monitored, so you can't "run away" because the rules are enforced. (You don't want to find out how, personally.)

"Shorting" is a tough, risky business. To answer your implicit question, if you have to ask about it on a public forum like this, you're not good enough to do it.

Answer 4

What if you can't find anyone willing to lend you the shares to short? Does it happen often? In real world, do we know actually know the individual/institutions we are borrowing shares from?

If no shares are available to borrow, you cannot short the shares. However, if the stock offers options, you can trade a synthetic short which mimics a short position in the underlying (sell an ATM call and use the proceeds to buy an ATM put).

Inability to borrow shares rarely happens with large cap stocks. It occurs more frequently with stocks with lower liquidity.

What if after you sell the stocks, there aren't any stocks for you to buy back? Then you end up owing shares to your borrowers? Will this happen in real life?

There are always shares to buy back. The question is how much you will have to pay for them.

I guess there must be some kinds of public ledger that keeps track of who borrows shares from whom. And there are also mechanisms to enforce the borrower must pay back. Otherwise, people can simply run away. I'm curious to know about how those enforcement mechanisms work.

Brokers keep track of who owns the shares and who is short the shares.

In the USA, the Reg T initial margin requirement for a short sale is 150%. The first 100% of the it can be satisfied by the proceeds of the short sale, leaving just a 50% actual cash requirement (collateral). The maintenance requirement is 125% of the current market value of the short sale (brokers can require higher amounts of either). You can't just walk away. If the value of the position drops below 125%, the broker will cover the position.