Short selling turns around the old adage “Buy low, sell high”, enabling you to “Sell high, buy low”.  You start by selling a share you don’t yet own, before buying it back later on.  If the share price falls between the two trades, you keep the difference, less fees and brokerage.

Short Selling - An Example

The strategy

In early 2008, XYZ shares (example only) were falling back from record highs.  Julie decided that they were likely to fall further.  So she used short selling to benefit from her view.

How she did it

On 10 Jan 2008, Julie placed a short for 15,000 XYZ shares at $6.28 per share.  This means she sold shares that she did not own.  To allow this, she must have borrowed the shares from someone else (her broker would have organised this for her).

The result

On 7 Feb 2008, Julie closed her short position, buying back 15,000 XYZ shares for $5.47 each.  After fees and brokerage, Julie earned a net profit of $11,881.98.

Here are the transactions that would have occured in this example:

If the trader bought the shares back at a higher price, it would cost more than the initial sale and the trade would have resulted in a loss.

There is much more to short selling that you should understand.

This example is hypothetical and for illustrative purposes only.  Past performance is not indicative of future performance. Short selling involves different risks to those affecting normal share investing.

You must bear in mind the settlement date of these trades. ASX currently schedules settlement for all trades on the third business day following the date the transaction was reported to the market unless the transaction is classed as "deferred delivery or deferred settlement" (in which case the trade(s) must be settled on the date specified by ASX). Settlements which are not met on the scheduled date incur fail fees. To avoid incurring fail fees you must either buy the shares to cover the short position on the day the short position is created or have borrowing arrangements in place with your executing broker to cover the settlement on the third business day.

Another consideration is the margin cover. Margin cover is a requirement of the ASX Market Rules and may be in cash or Cash Market Products. If your broker permits short selling, they must obtain a margin cover of 20% of the value of the trade before placing your short sale order. Whenever the market price of your short sold security rises in excess of 10% of the contract price you must provide additional margin cover of 100% to your broker.

As an example, if you short sell 1,000 BHP at $16.00, the total trade value is 1,000x16, or $16,000. You must provide your broker with margin cover of 20% of $16,000, i.e. $3,200.

If the price of BHP rises by 15% while you are short sold, you are required to provide additional margin cover of 100%. That is, if the price increases by $2.40, you must provide your broker with additional margin cover of $2,400 (100% of $2.40 price rise x 1,000 shares).

Short selling must take place in accordance with the ASX Market Rules. Short selling is not permitted if:

• The security is under an offer of takeover.
• The security is not a designated Approved Short Sale Product or Approved Short Sale ETF.
• The order's price is lower than the last sale price, e.g. you cannot place an order to short sell BHP for $17.00 if BHP last traded at $17.01 or higher.
• No more than 10% of the securities on issue may be short sold.