Transcript: Understand margin when you short sell stock

[Music plays.]

[CIBC logo
CIBC Investor’s Edge
Understand margin when you short sell stock.

[A closed laptop is shown, which opens to show a bar graph and a line graph on its monitor.]

[Rob, a CIBC Investor’s Edge employee, stands and speaks.]

Understand margin when you short sell stock. One of the strategies investors use to trade in a declining stock market is short selling. Let’s quickly revisit this concept, as some of you may be hearing about it for the first time. If that’s you, we’d recommend you watch our previous videos on short selling that include the risks involved, as this may not be for everyone. We’ll provide the links in the description. 

[A line graph is shown, titled “Short sell”. The Y axis, labelled “XYZ share price”, indicates dollar amounts: $30, $40, $50, $60. The graph line moves up and down with an overall upward trajectory, ending at $50. A dotted line is shown along this ending point, which is labelled “short sell”. The graph moves to the right with the graph line ultimately going down and ending at $25. Another dotted line shows this point as the “repurchase price”. In between the short sell point and the repurchase point is “Profit”.]

Remember, when you short sell stock, you borrow stock and sell it, profiting if you can buy it back later at a lower price.

[The same graph is shown. However, this time as the graph moves to the right the graph goes up, ending at $61, which is labelled “repurchase price”. The difference between the repurchase price and the short sell is labelled “Loss”.]

Alternatively, you’ll face a loss if you have to buy it back at a higher price. Let’s walk through what happens when you short sell a stock. You’ve spotted a stock XYZ that you think is overpriced.

[The same graph is shown with the graph line ending in $50 and labelled “current price”.]

XYZ is currently trading at $50, so you enter an order to short sell 100 shares at $50. The margin rate of the stock will determine how much you’ll need initially. If the margin rate is 50%, you’ll need 50% of the trade value already in your account when you place a trade, and 150% of the value to hold the position.

[To Rob’s right an icon of a percentage sign appears, labelled “If XYZ margin rate = 50%”. Below this, an icon of dollars appears, labelled “Need 50% of trade value to place trade”. Below this, an icon of a fluctuating graph appears, labelled “150% of trade value to hold the position”.]

That could be cash or other marginable securities or a combination of both. Let’s see what this means by looking at the numbers. In this example, you’ll initially need $2,500 excess or available margin in your account when the trade is placed.

[A graphic is shown titled: “Initial vs. maintenance margin.” To the left there is a label: “Initial margin in account”. To the right of this is an explanation: 50% × ($50 × 100) = $2,500. Below this is a label on the left: “Short sale proceeds”. The explanation appears to the right: 100 shares × $50 = $5,000. Another label appears below: “Margin to maintain”, with an explanation: 150%.]

50% of 50 times 100 equals $2,500. When you place a trade and sell the borrowed stock, the proceeds of the sale are deposited to your account. In this example, that’s 100 shares times $50 equals $5,000. We haven’t included the broker’s commissions in these examples.

Since the short sale requires margin of 150%, this means that you must have 1.5 times the current value of the stock in your account to hold the short position.

[The $5,000 is circled and “× 1.5” is added beside it.]

The short sale itself results in funds being deposited to your account, and you needed 50% of the trade value to initiate the trade. That’s 150% times 50 times 100 equals $7,500. Initial margin in account is equal to $2,500. Funds deposited once the stock is sold is $5,000, for a total of $7,500.

[The “margin to maintain” label’s explanation changes to: 150% × $50 × 100 = $7,500. As the transaction is summarized each total is highlighted.]

So the total margin required is $7,500, which is $5,000 generated from the sale of the stock, plus an additional $2,500 of available margin already in your account.

[To the right of Rob the icon of % circles is labelled “$7,500 Total margin required”. Below two dollar icons appear, labelled “$5,000 Sale proceeds + $2,500 Initial margin”.]

Next, let’s look at what happens after the short sale is completed. In scenario 1, the price of XYZ moves lower, as you were hoping. Imagine that XYZ is now trading at $30.

[The same graph appears, now titled: “Scenario 1: stock price declines”. The graph line has downward trajectory moving from the short sell amount of $50 down to the current share price of $30.]

The value of XYZ is currently trading at 100 shares times $30 equals $3,000. The margin needed to maintain 150% of this $3,000 is $4,500.

[A graphic titled: Scenario 1: stock price declines. To the left is a label: “Value of XYZ”. The explanation is shown to the right: 100 shares × $30 = $3,000. Below this, the label indicates: “Margin to maintain” and the explanation is: 150% × $3,000 = $4,500. A new label is interjected between the two: “Initial margin in account” with an explanation of: $7,500.]

The initial margin in the account is $7,500, and the excess margin currently in your account is $7,500  minus $4,500 equals $3,000.

[In the same graphic a new item is shown below the others, labelled “Excess margin in account”. The $7,500 amount is highlighted. The $4,500 amount is highlighted and below these amounts the new explanation of “Excess margin in account” is: “+$3,000”.]

There’s excess margin of $3,000 in the account that could be used to put on additional positions, withdrawn or act as a buffer or safety net in the event that XYZ moves higher in the future.

In scenario number 2, the price of XYZ moves higher — a negative result for you. Imagine that XYZ is now trading at $60. The value of XYZ is currently 100 shares times $60 equals $6,000. The margin needed to maintain at 150% is $9,000. The initial margin in the account is $7,500 and the account is now under margin by a difference of $7,500 minus $9,000, or $1,500 dollars.

[A graphic titled: “Scenario 2: stock price rises”. The graph is the same as previous graphs, with the graph line ending at $50. The graph moves to the right and the line rises from the short sell point of $50 to approximately $55. Another point above this appears and is labelled current share price.]

[A graphic is shown summarizing this. To the left is the label: “Value of XYZ”. To the right is: $100 shares × $60 = $6,000. Below a new label is shown: “Margin to maintain” with the explanation showing to the right: $150% × $6,000 = $9,000. In between these two lines a new label is shown: “Initial margin in account”. The explanation is $7,500. Below a new label appears:” Account is under margin”. The $7,500 is highlighted along with the $9,000. This sum is then indicated below: -$1,500.]

With scenario 2, you receive a margin call and you need to deposit cash or margin eligible securities to bring the account back in line. You can also close or partially close one of your short positions to keep the account in good standing. This margin calculation is performed every trading day.

[A summarization appears to the right of Rob: “When receiving margin call”. Below a dollar icon appears, labelled “Deposit cash or margin-eligible securities”. Below this, the word “Or”. Below this, a new icon of a crossed-out dollar, labelled “Close or partially close short positions”.]

Let’s talk for a minute about the margin rate for different stocks. This rate can change without notice and can be influenced by many factors, including the stock’s volatility, current price level and other factors.

[An icon of a percentage sign appears, labelled “Margin rates can change without notice”. To the right an explanatory listing is shown titled: “Margin rates influenced by many factors including: Stock volatility; Current price level; Other factors”.]

If the stock’s margin rate drops and your account does not have sufficient buying power, you’d receive a margin call. If you don’t take action, Investor’s Edge may do so on your behalf to bring your buying power back on side.

One of the other special features of short selling is that the short seller is responsible for paying the dividend on the borrowed stock, which will be automatically withdrawn from your account. Since short selling requires a margin account and margin comes with its own advantages and disadvantages, we recommend that you also watch our video on margin trading and how to make it work for you.

We’ve provided the link in the description. You can also learn more about margin trading in short selling in the Investor’s Edge Learn Library. The link is in the description as well. Happy trading.

[Trade smarter, not harder with CIBC Investor’s Edge.]

[CIBC Investor’s Edge is a division of CIBC Investor Services Inc. This document is provided for general informational purposes only and does not constitute investment advice. The information contained in this document has been obtained from sources believed to be reliable and believed to be accurate at the time publishing, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change. The CIBC logo is a registered trademark of CIBC. The material and its contents may not be reproduced without the express written consent of CIBC.]

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