Short Sale of Stocks

What is a Short Sale of Stocks?

A short sale of stocks refers to the transaction in which the seller first borrows the Security from the Broker and then sells it in the open market and, thereafter, buys the Security back at an appropriate time to pay it back to the Broker. In this, the Buyer of the Security has to buy back the Stock from the Broker in order to cover his open position. They are basically called as a Margin Transactions in which the settlement of the trade happens on the Net margins and not actual delivery of the Stock. There are certain guidelines that need to be followed for the Short Selling to be done by the investors in respect of minimum margins to be maintained with the Brokers.

Short-Sale-of-Stock

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Source: Short Sale of Stocks (wallstreetmojo.com)

Examples of How Short Sales Stocks Process Works?

Below are some examples of how short the sale of stocks works?

Short Sale Stocks Example #1

Let us assume that an investor Short Sells Security on the Exchange by borrowing the same from a Broker, i.e., 1000 shares @ $20 = $20,000. The stock price moves down by $2. In this case, the investor needs to buy back the Security from the Broker @ $18 in order to cover the position, and hence there is a profit of $2,000 on this transaction, which has been paid by the Broker to the investor.

Below mentioned are some of the Journal Entries that need to be passed after Short Selling.

Short sale Example 1

The Stock moves down by $2 to $18.

Short sale Example 1-1

At the time of settlement

Example 1-2

In the Above Examples, the Trader makes $2,000 just by putting a trade on the Stock ExchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more via a Broker without possessing that Stock in his Demat Account. For this, the Broker charges a certain amount of Fee to the Trader to execute the trade, which is known as a Transaction fee, which gets deducted from the initial margin the Trader has given to the Broker as a Security.

Thus the trade had made a profit just by selling the Security at a higher rate and then buying it back from the market when the rate dropped below the Sell rate, which has resulted in a net profit of $2,000 to the Trader and Fee income to the Broker for availing this facility.

Short Sale Example #2

Let us assume that in case of a Real Estate Transaction, ABC Limited owns a property whose market value is $5,00,000, and the debt owed against the same is $ 4,50,000. IF the Company wishes to sell the property at $ 3,50,000, it will have to take NOC from all the lenders in order to go ahead with the transactions since their Financial interest has been affected due to the lower realization in the same. If the lender agrees on the sale, it would be referred to as the Short Sale of the Deal by $ 1,00,000

Advantages of Short Sale of Stocks

Below are some of the Advantages.

Disadvantages

The following are the disadvantages of a short sale of stocks.

This has been a guide to a short sale of stocks and its meaning. Here we discuss examples of a short sale of stocks along with journal entries, advantages, and disadvantages. You can learn more about Financing from the following articles –

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