Lending shares is crucial for bears to operate, investors who bet on the fall of a listed security to make a profit. It is the dynamic that has been seen with Grifols and the Gotham fund, but it is not the only scenario in which titles are left.
From keeping the market functioning properly to liquidating contracts, there are several reasons why someone might need to borrow shares and pay for it. Speculating is not always behind. In any case, does it also help individuals benefit?
Those who steal the most spotlights by borrowing shares are the bears. Technically, the operation of being short is called naked choice or short selling. “It is very risky to do so. The losses can be unlimited: the stock can fall to 0 at most, but it can revalue to infinity. You risk a lot because it is something asymmetrical, you have little to gain and a lot to lose,” comments Jaume Puig. , director of GVC Gaesco Gestión.
“Their objective is for the stock to fall to make money. For example, borrow them at 10 euros, sell them and wait for the stock to fall and then buy them back and return them,” he reviews. There are funds that are dedicated solely to this, but as the market tends to rise in the long run, their performance can end up being “disastrous.”
On paper, operating short has a positive function, which is to provide liquidity to the market and avoid upward bubbles, he states. Because it may happen that no one wants to sell or few want to do so, which inflates the value if the trend is upward. “The original idea in its conception was that anyone could sell, even if they were not the holder of the title, and it would provide liquidity. It would stabilize prices… But in practice it is perverted and it is possible to take advantage of the market sentiment when it falls, causing let it fall more,” warns Puig.
Although the bears and shorts get the attention, the loan of shares helps for other assumptions, Puig highlights. As among market makers, entities that are in charge of generating liquidity in the market and that need to buy or sell to maintain certain ranges, for which they can borrow if there are no people willing to sell. Or as in price arbitrage processes if the same security is listed in different markets; for index futures arbitrage, or for settlements, when borrowing is requested to settle contracts without penalties in case there have been errors in execution.
They also serve for operations such as hedging bonds convertible into shares or in pairs trading, a modality where you operate with two companies in the same sector, correlate them and buy or sell securities depending on whether they rise or fall, closing the count from GVC Gaesco.
“In none of these cases are shares borrowed to go short and try to make the price go down,” Puig reiterates. Nor in those that are more linked to taxation and the payment of taxes, borrowing shares for the recovery of withheld international dividends or to guarantee zero taxation of foundations.
Logically, if there are investors who borrow them, there are others who leave them. They are mainly funds or insurance companies, which invest for the long term – they do not want to sell – and have an extra option to make their securities in their portfolio profitable. In exchange for leaving them for a certain number of days or months, they charge interest and then recover the title. The millionaire business is such that in recent years it has given rise to platforms such as Sharegain, where both are located.
Although it is not the only reason, again, it is the one that people see the most: why do the bears have such an impact with reduced participations? “Fear is free. If you are on a plane and someone says “smoke” there is a scandal… The first reaction is to sell, you don’t wait to check it, especially if you are not an institutional or stable investor,” Victor compares Alvargonzález, strategy director of the independent financial advisory firm Nextep Finance. A “just in case.” Furthermore, if a bearish person intends to attack a large company it may be less noticeable, but if he goes after small capitalizations, it is more noticeable due to the lower liquidity. Something that could be seen in the most recent cases.
If professionals make mistakes and can end up with losses, as Puig commented, is it better for individuals to operate short or go after bearish funds? “People can do it, but about what they have adequate advice and can control,” warns Alvargonzález. “If we talk about values, individuals do not have the analytical capacity to know if they are dealing with a reality (that the company is actually inflated) or an operation that has a strategy behind it. It is not convenient to be managed, to be an instrument,” she points out. “When someone launches the operation it means that they have already gone short. The individual who enters later is the ammunition to continue with the process.”
Thus, it is better to control cases. For example, it could make sense to do so against the American stock market after the inflation crisis and the war in Ukraine broke out, when it was more justified and clear that it could fall, he exemplifies. “An individual can perfectly bet against an asset, but he must have very clear reasons. If he does it without knowing the situation, you can be cannon fodder.”
