Mea Culpa

I'd like to correct a post I made yesterday on short-selling stocks.

A listener wrote in to ask what a person who loans a stock to short seller has to gain? Short selling can seem a bit counterintuitive but I always thought I understood it. When I answered the question yesterday, this is what I wrote:

When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. How much you make or lose from here depends on what happens to the stock's price.

If the price of the shares drops, you have to "cover" your bet by buying back the shares, and the broker returns them to the lender. Your profit is the difference between the price at which the stock was sold and the cost to buy it back.

But here's your risk. If the price of the shares increases, you have to buy it back at the higher price, and you lose money. Whoever loaned the shares can make out big. If, say, the stock rises 100%, they just made a lot of money.

As a few of our blog readers quickly pointed out (and a close broker friend of mine in Boston explained to me this morning along with a few choice put downs about my intelligence), I got it wrong.

Here is the correct answer: The person "loaning" the stock has nothing to gain here and may in fact never realize their shares were loaned in the first place. The upside here is to the broker or middleman who takes a fee for the transaction. As my (now former) broker friend told me this morning, the fees can be small but can become real money if a lot of shares are involved.

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