Costs Associated With Short Selling

Continuation from yesterday…..(Why Short Selling Is Important)

Additional costs associated with taking a short position.

Typically and depending on your broker the transactional costs associated with taking a short position are equal to you taking a long position. However, you do tend to pay more though margin interest and dividend payments. For instance, if the short position begins to move against you, money will be removed from your cash balance and into your margin account. If you do not have enough cash to cover the losses you begin to borrow on margin, thereby accruing margin interest charges. Otherwise, if you do have enough cash in your account to cover your short losses (if any), no margin interest costs will be inquired.

When it comes to dividend payments you are responsible for paying underlying stock’s dividend if you are holding the stock short ex-dividend date. Without getting into the details of the entire process, you must pay the dividend on the underlying security if 1. The underlying security has a dividend associated with it and 2. You are holding this security short on ex-dividend date. At times such costs can be significant.

Yet, for the most part, both costs can be mitigated or largely eliminated when short selling is approached in a correct way. When it comes to margin interest, simply maintain a cash balance big enough to cover your short positions and any losses that you might inquire if the positions move against you. That way your margin account is never triggered and no interest charges occur. In terms of dividends, either avoid shorting stocks that pay dividends or get out of your position before the ex-dividend date is triggered. Plus, unless you are shorting a specific stock for company specific reasons, you shouldn’t be shorting stocks that pay dividends. Simply choose another non dividend paying stock in the same industry and short that one. And if you are to do both, the costs of going short become equal to the costs of going long.

In summary and as the points above show, when short selling is approached in an appropriate way, the risks associated with the practice are reduced to a bare minimum. And while the overall risk profile might be slightly higher than going long, when executed properly, going short is not nearly as risky as the investment industry makes it out to be. If anything, the practice plays a crucial part in a powerful investment approach discussed bellow.

That brings us a full circle and back to the question of which investment approach is the best?

To Be Continued Tomorrow…..