Why would a stock broker let you short a stock?
I don’t fully understanding the concept of shorting a stock, but I was wondering why anyone would let a person “borrow” their shares so that that person can short it. If people believe that a certain stock will go down in value, then who would want to let someone short their stock? Are there other parts to shorting that the broker makes money off of?
There are two questions here:
a) Why would someone let you short their stock?
If they knew about it, they wouldn’t as they are just increasing the number of sellers in the market decreasing their own share price. When things get really ugly with short sellers companies have been known to advise their shareholders to call their brokers and ask to hold the stock in certificate form so the stock can’t be shorted. The argument is that stopping short sellers is good for their stock price. Margin account agreements give brokers the right to borrow stock for short sellers with no compensation for the borrow.
If you are big enough, you would let someone borrow your stock for short selling because you get borrow fees on the stock. At hedge funds where I have worked we have paid borrow fees of 3% or more per MONTH. If you retain ownership interest in a stock you think is going up and someone is willing to pay you an extra 3%/month on top of that, it’s hard to say no. The stock with borrow fees of 3%/month is of course the stuff that your broker won’t let you short because they are collecting borrow fees on it from hedge funds.
b) Why would your broker let you short stock?
Your broker couldn’t give a rat’s ass about market efficiency. Your broker does it for commissions plus the (nearly) interest-free loan. When you short the stock, the proceeds for the sale go into your margin account where they probably need to stay at little or no interest. The brokerage firm of course can invest that money in low-risk deposits and collect the interest. And of course when you short the stock there are two commissions, the short and then the cover.