Shorting Rules in the Stock Market
A short sale in the stock market is a transaction in which you sell shares that you have borrowed from your broker. You agree to buy shares later and return them to the broker. You make a profit if the stock price falls and you eventually buy the shares at a lower price than you previously sold them for. Short sales are governed by Securities and Exchange Commission regulations, stock exchange rules and individual broker policies.
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Margin Account
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You must have a margin account with your broker to initiate a short sale in the stock market. Margin accounts differ from cash accounts because you can borrow money or securities. A margin account is necessary because you are required to borrow the shares when you short-sell a stock. In addition, all funds in your account are collateral for the loan.
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Your broker must either own or borrow the shares you are required to borrow before a short sale can be initiated. Failure to secure the shares before initiating a short sale is called naked short selling. In 2009, the SEC implemented anti-fraud rules that banned short selling.
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Margin Requirements
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Under Federal Reserve Board regulations, you must have a minimum of 150 percent of the value of the shares in your account to initiate a short sale. In addition, you must meet minimum maintenance requirements. The NYSE and most other stock exchanges set a minimum maintenance requirement of 125 percent of the value of the stock. Brokers often impose more stringent requirements of 130 percent to 140 percent. If the stock increases in price to the point your account balance does not meet the minimum, you must deposit more money.
Other Rules
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Because you don't actually own shares of the stock, you cannot receive any dividends paid on the shares while the short sale is open. Dividends go to the owner of the shares. For the same reason, you may not claim any profits as capital gains for tax purposes. In 2007, the SEC rescinded the uptick rule, which prohibited the initiation of a short sale if a stock was falling in price. However, as of 2009, the SEC was considering implementing a new uptick rule. A ban on short sales during a trading session once a stock falls by 10 percent was under consideration.
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