Hedge Fund Question of the Week – Winter Edition – No. 2

By Zach Canonico, Portfolio Finance/Operations Executive

What are two initial points to consider when taking on short positions?

Answer: Stability and cost optimization.

Shorting stock can present challenges for a firm’s treasury department. A key consideration involves the stability of the borrow. Will the short position (or borrowed stock) remain available throughout the duration of the firm’s investment thesis?

An important consideration involves holding the position through a well-diversified set of counterparties. If the stock happens to be in particular high demand for shorting (i.e., a “hard to borrow”), a firm’s treasury department will need to dig a little deeper and also understand the diversity of a counterparty’s sources and stability of the underlying stock owner (i.e., passive vs. active, index tracking, etc.).

A second consideration involves minimizing the cost of shorting a stock. When a position is hard to borrow, counterparties will charge a premium for lending these stocks. Greater transparency over the past few years has reduced the cost of borrow as well as variation in costs charged from one counterparty to another. Nevertheless, this is an area a treasury department should scrutinize when putting on a short position and regularly throughout life of the investment.