“Hard to borrow” refers to a security that is difficult for traders to locate and borrow for the purpose of short selling due to high demand and limited supply.
Understanding hard to borrow stocks
To execute a short sale, a trader must first borrow shares from a brokerage. Brokers source these shares from their own inventory, margin accounts of other clients, or external institutional lenders. When a large number of market participants attempt to short the same stock simultaneously, or when a company has a low number of shares available for public trading, the available pool of borrowable shares is depleted. The brokerage then designates the stock as hard to borrow.
Trading hard to borrow stocks involves additional expenses. Brokers charge a specific fee to locate and lend these shares, which fluctuates daily based on market supply and demand. This fee is calculated as an annualized percentage of the value of the borrowed shares and is applied to the trader’s account. This creates a carrying cost that traders must subtract from their potential profits. Holding a short position on a hard to borrow stock over an extended timeframe results in compounding daily fees.
Financial regulators across different countries require brokers to locate borrowable shares before permitting a short sale. This requirement prevents naked short selling, a practice where shares are sold short without ever being borrowed. When a stock enters hard to borrow status, the broker takes affirmative steps to find the shares before the trade goes through. The hard to borrow designation is not permanent. A security that is easy to borrow on Monday might become hard to borrow by Wednesday following an earnings report or corporate announcement that attracts sudden short selling interest.
Example
Consider an international agricultural firm named Elephant Peanut Farms Ltd. that recently reported poor harvest yields. Fellow Elephants in the trading community decide to short the stock, expecting the share price to fall. Elephant Peanut Farms Ltd. has a small public float, and the surge in short selling quickly consumes the brokerages’ available share inventories. The stock is added to the hard to borrow list. If an Elephant wants to short 1,000 shares at $20 per share, the total position value is $20,000. If the broker applies a 40 percent hard to borrow fee, the annualized cost to maintain the short is $8,000. The trader is charged a prorated daily fee of approximately $21.91 to hold the short position, which applies every day the position remains open.