Short Selling Australian Stocks

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1 Short Selling Australian Stocks What is Short Selling? The best way to explain short selling is to show the difference between going long and going short. Going Long and Making a Profit To go long means that we buy a stock with a view to making a profit by selling it later at a higher price. A profit is made if we sell the stock we bought at a higher price than we paid: Monday: We buy 1000 shares in XYZ Ltd at \$1.00 We are now said to be long 1000 XYZ at \$1.00 Friday: We sell the 1000 shares in XYZ Ltd at \$2.00 We are now said to have closed our long position. Result: Proceeds of sale minus cost of purchase - (1000 x 2.00) (1000 x 1.00) = \$ 1000 As the result is positive, we have made a profit. Going Long and Making a Loss A loss is made on a long position, if we sell the stock we bought at a lower price than we paid: Monday: We 1000 shares in XYZ Ltd at \$2.00 We are now said to be long 1000 XYZ at \$2.00 Friday: We sell the 1000 shares in XYZ Ltd at \$1.00 We are now said to have closed our long position. Result: Proceeds of sale minus cost of purchase - (1000 x 1.00) (1000 x 2.00) = Minus \$ 1000 As the result is negative, we have made a loss. Going Short and Making a Profit To go short means that we sell a stock with a view to making a profit by later buying it at a lower price. A profit is made if we buy the stock we sold at a lower price than we sold for: Monday: We sell 1000 shares in XYZ Ltd at \$2.00 We are now said to be short 1000 XYZ at \$2.00 Copyright Colin Nicholson Page 1

5 number of shares is within the 10% limit. When the deal is executed, the sale is flagged to the market as a short sale with the parameter S. It is also shown on the contract note as a short sale. Secondly, the broker must secure from the short seller a margin of 20% or more of the value of the short sale, which is held in trust until the short sale is covered by repurchasing the shares. The margin may be in the form of cash or listed securities. In the case of securities, they are counted at up to 90% of their market value, the actual discount being at the discretion of the broker. Should the price of the shares sold short rise by 10%, the broker will require additional cash or up to 90% of the value of securities to be lodged to bring the margin back to 20%. Similarly, if the value of the securities lodged as margin falls, additional margin will be required. The broker also has the power to at any time call for margin to the extent of the entire cost of covering the short position. If this call is not met promptly, the broker has the power to cover the position on your behalf. Thirdly, the broker and the short seller have a responsibility to deliver scrip on the T+3 rules. This is done by borrowing stock, naturally at a cost. This process carries a risk and is costly to monitor and maintain, so additional fees may be charged by the broker. Generally, the short seller is also required to pay the lender any dividends and the lender may also be entitled to any attaching franking credits, which, if the short seller cannot supply, must be settled in cash in addition to the amount of the dividend. The cost of borrowing scrip can, of course, be offset by the income from placing the up to 80% of capital not required as margin on the money market. Most brokers will also require the short seller to sign a Risk Disclosure agreement similar to that required by the Australian Options Market. Conclusion It is possible to short sell Australian shares and it happens all the time. The advantage may lie in the fact that markets generally fall much more quickly than they rise. However, the process is more complicated than taking a long position and does involve greater risk. Copyright Colin Nicholson Page 5

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