Short Sell

[vitamin]

Why is that a short seller may be subject to margin calls if the stock price increases?

Thanks!!

 

[JeffJ21]

the broker may call into question his buying power, as far as covering his position.

 

[CFAHouston]

because with short seller, the sellers intention is to buy the share back when prices goes down. He initially borrows the share, sells it current price, and assumes that prices will go down so he will make a profit.

However, if prices goes up, he will be at a loss, so receives a margin call.

Hope this made sense.

 

[PortfolioMgr]

When you are long something you are at typically 100% margin meaning you put up 100% of the price. So if it goes down there is no risk to the bank. You buy a stock for $100 you give the bank $100 and they buy the stock.

For shorts that is not the case. Let's say you have 10% margin. That means if you short a $100 stock at 10% margin you only have to give the bank $10. If the stock goes down like you want it go then you make money. If it goes up you owe the bank the losses so they currently have $10 collateral. If it keeps going up let's say to $150 you now owe the bank another $40 so at some point you are a major credit risk to them meaning you may not pay. So therefore, as the stock moves against you they make you put up more money. Different brokers/banks have different rules. So if you originally give them $10 and the stock goes to $110 so you are now breaking even on your deposit of $10 they bank may say ok now give us another $10 or else they will cover your short and use your original $10 to cover the losses.

 

[jamespucyk]

Gotta love the Schweser calculations of margin call positions though:

1-IM / 1-MM * P = MC for long position
1+IM/1+MM * P = MC for Short position