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Shorting Small Caps

Shorting Small Caps? Shorting Disabled?

Q:What is ‘naked’ short-selling?

Why doesn’t my broker let me short certain penny stocks? A: The problem in borrowing non-marginable stocks lies in the fact that since they are not marginable they have not been hypothecated to the broker. Therefore the broker cannot loan them to a short seller without the owner’s permission. This complicates the process, so for retail traders it becomes difficult.

In other words for any brokerage company to allow Client A to short stock XYZ, then that means that they have to find a client B that owns stock XYZ for client A to ‘borrow’. Penny stocks have lower volume, thus a lower possibility that the broker will find that stock so it can be ‘borrowed’.

Q:What is ‘naked’ short-selling?

I’ve tried to open a short position on a share but received a prompt: ‘Trading Short for selected instrument disabled.’

This share has issued a profit warning with a consequent crash in its share price…

A: Your CFD provider would have applied the restriction for a good reason. So, for instance, if as you have said the stock price has suffered a major crash in a short period of time, then as even more traders attempt to jump abroad and short it on the way down – this can cause problems.

Keep in mind that anyone who wants to bet on a stock price falling needs a party on the other end willing to lend the stock to sell at the prevailing market price, and then return it back once the position is closed. For blue chip stocks with relatively stable prices, CFD providers don’t usually have problems finding sufficient stock to ‘borrow’ to hedge their exposure when a client opens a short position. However, it is much more difficult to find ‘borrowable’ stock in markets that are in crisis mode, thereby the ‘shorting disabled’ function may be activated on markets where contracts for difference brokers are unable to hedge the corresponding shorts.

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