Prime Broker Shenanigans

I was shocked and amazed when I was shown the calculation prime brokers and retail brokers for that matter, charge for short borrow costs. This was pointed out to me on twitter by @walt373 in regards to a short position in SunTech Powers.

Here’s the “legalese”:

In determining the cash deposit required to collateralize a stock borrow position, the general industry convention is for the lender to require a deposit equal to 102% of the prior business day’s settlement price, rounded up to the nearest whole dollar and then multiplied by the number of shares borrowed.  As borrow rates are determined based upon the value of the loan collateral, this convention impacts the cost of maintaining the short position, with the impact being most significant in the case of low-priced and hard-to-borrow shares.

Example 1

Sell short 100,000 shares of ABC at a price of $1.50

Short sale proceeds received = $150,000.00

Assume the price of ABC falls to $0.25 and the stock has a borrow fee rate of 50%

Short stock collateral value calculation

Price = 0.25 x 102% = 0.255; round up to $1.00

Value = 100,000 shares x $1.00 = $100,000.00

Borrow fee = $100,000 x 50% / 360 days in year = $138.89 per day

I underlined three sentences above, “general industry convention”, “rounded up to nearest whole dollar”, and “most significant in low-priced stocks”. STP happens to be one of these low priced stocks at $1.00 lasts. Without getting into too many details on the stock thesis, let’s just look how much money your brokers’ lending desk stands to make based on small changes to the stock price:

If the stock closes at $1.00 and you decide to short $1MM worth of stock the value of the short position is $1,000,000 and 1MM shares . Your PB will multiply this value by the borrow rate and charge you per day. Simple enough. What if the stock then closes at $1.01? The VALUE (not borrow rate) is rounded UP to the nearest dollar value or in this case $2.00. According to the PB you are now short $2,000,000 worth of stock! Your daily rate to the borrow the stock is now 2x!!

I found that amazing! These low priced stocks are difficult situations to trade due to all the peculiar interests of the various players that control the stock near or at bankruptcy. Most of the institutional holders have probably exited the stock and your left with market makers, lending desks, and distressed investors and it is hard to figure out the axe in the name! In the meantime, the lending desks look like winners!



~ by largecaptrader on September 5, 2013.

One Response to “Prime Broker Shenanigans”

  1. nice

    Dan Jacome, CAIA
    Associate Analyst – Specialty Retail & Softlines, Consumer Equity Research
    Oppenheimer & Co. Inc. | 85 Broad Street | New York, NY 10004
    +1 212 667 8187 | EMAIL:

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