Short term interest rate = 0.5%
Short position financing cost = short term interest rate - 2.5%
Hence cost is = 0.5%-2.5% = -2%
So your account is credited 2% of your total position per year
However there is a very important thing to remember about being short - you have to actually borrow the shares so that you can short them. This is certainly not free and varies wildly between stocks (a Chinese AIM stock such as China Chaintek United Co will be vastly more expensive to borrow than say Intercontinental Hotels Group). Hence the actual cost is:
Actual Financing Cost = short term interest rate + borrowing costs- 2.5%
Borrowing costs are very important to understand before you short anything. These will often eat up the short credit (the money the broker pays you) and for smaller stocks will typically turn the interest rate you receive from a negative number into a positive interest rate that you have to pay. In this example if the borrowing cost for the stock is greater than 2% your account will have money taken out of it instead of getting money put in.
The basic way that short selling works is that you borrow shares, sell them and then buy them back (hopefully at a lower price) and then return the shares to repay the loan. In other words you could take out a loan of 100 shares and then the loan by delivering 100 shares but keep or pay the difference between the price you sold the shares you borrowed and the price you bought them back at. This is why we talk about "short selling" or "selling short" as you are literally selling the shares you think are going to fall even though you don't own them.
So who's shares are you selling? Typically the shares being sold will come from people looking to boost their returns such as pension funds, endowments or big banks looking to lend out what they have on their books such as the Bank of New York Mellon or State Street. They of course don't do this for free and will charge you an interest rate on the loan. Some brokers will even let you lend the stock in your brokerage account out for a cut of the fee.
It is impossible to know what the borrowing costs are without calling your broker to get a quote. Typically, big shares are vastly cheaper than small shares. In UK short selling is notoriously expensive post financial crisis with micro-cap stocks having lending fees north of 20% (according to Simon Cawkwell at Master Investor).
Ensure that before you open a short position you know what the borrowing cost is. I fear that most people spread betting simply don't bother with this. This is a bad idea and quite dangerous. Spread betting requires extreme care at all times and neglecting expenses or adopting lax accounting standards will seriously hurt you in the not particularly long term.
Borrowing Costs
The basic way that short selling works is that you borrow shares, sell them and then buy them back (hopefully at a lower price) and then return the shares to repay the loan. In other words you could take out a loan of 100 shares and then the loan by delivering 100 shares but keep or pay the difference between the price you sold the shares you borrowed and the price you bought them back at. This is why we talk about "short selling" or "selling short" as you are literally selling the shares you think are going to fall even though you don't own them.
So who's shares are you selling? Typically the shares being sold will come from people looking to boost their returns such as pension funds, endowments or big banks looking to lend out what they have on their books such as the Bank of New York Mellon or State Street. They of course don't do this for free and will charge you an interest rate on the loan. Some brokers will even let you lend the stock in your brokerage account out for a cut of the fee.
It is impossible to know what the borrowing costs are without calling your broker to get a quote. Typically, big shares are vastly cheaper than small shares. In UK short selling is notoriously expensive post financial crisis with micro-cap stocks having lending fees north of 20% (according to Simon Cawkwell at Master Investor).
Ensure that before you open a short position you know what the borrowing cost is. I fear that most people spread betting simply don't bother with this. This is a bad idea and quite dangerous. Spread betting requires extreme care at all times and neglecting expenses or adopting lax accounting standards will seriously hurt you in the not particularly long term.
Takeaway...
To summaries the article the basic points to be aware of are as follows:
Although it is possible under certain circumstance to get paid interest on short positions it is important to take into account the cost of borrowing the stock. The fact that you could be receiving a small amount of money for the short should not factor significantly into your trading thesis.
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