From: ask@cbnews.cb.att.com (Arthur S. Kamlet)
Subject: Re: Concept of selling short.
Organization: AT&T Bell Laboratories,  Columbus, Ohio
Distribution: usa
Date: Mon, 9 Nov 1992 04:23:42 GMT

In article <1dc4g8INNko1@sixgun.East.Sun.COM> awang@sunpix.East.Sun.COM (Angus Wang - Sun NC Development Center) writes:
>I'm trying to understand the concept & details of selling a stock short,
>but have a few questions.  I understand that what you are basically doing
>is selling shares that you do not have (usu. it's shares that the broker has)
>and promising to supply those shares at a later date, hoping that you
>can buy those shares at a lower price.
>
>Questions are :
>
>1. Who/What determines when you have to come up with those shares?  Can
>	they be "called" at any time?

The broker will set certain conditions, including the maount of
collateral you must put up, and cash reserves, and possibly loans on
which you might pay interest.  Any cash you receive from the sale
will most likely not earn interest.  Any dividends the stock pays
are paid by you.    As the price rises the amount fo collateral you
put in goes up.   So as the price rises the broker requires you to
put more and more of your own funds or stocks in the account.

At some point you will try to cut your losses in face of a rising
stock.  In fact, if the stock goes up a spiral (loop) can result:

       - Stock rises
       - Broker may issue call for you to add collateral or
         close out your short position
       - Some short holders buy the stock back 
       - This drives the stock up more
       - Broker may issue call for you to add collateral or
         close out your short position
       - More short holders buy the stock back
       - This  drives the stock up more
       - Broker may issue call for you to add collateral or
         close out your short position

       - you are now in a loop

Usually, if you continue to meet your obligations and keepng cash
or other collateral you will probably not be required to buy back,
but the broker can force this under certain conditions.

>2. How does the IRS figure gains for taxing? Do you not get taxed on
>	your profit until you have settled (which could be in a
>	different tax year)?  Do you get hit with income in the year
>	you sell short & then hit with gains in the year you settle?


The short sale does not generate a taxable event.  For ordinary
short sales of stock, you can hold the stock short forever.  When
you close out that transaction (buy back the stock) then and only
then you have incurred a taxable event.   The cost basis is probably
the price at which you buy back the stock and the sales price is the
price you first got when you sold short.  The gain/loss on short
sales is always short term even if you held the stock short over 1
year.

This may be counter-intuitive.  Especially the part that says you
can sell short, get cash in your account immediately, and not report
the transaction to the IRS until you close the transaction.

And it does not hold for certain other securities such as futures
and index options and certain straddle positions,  where you have to
true up gains as of year end.  That is, for those transactions, you
have to calculate gains based on market value at year end and report
that as income.  (not losses)

But for shorting ordinary stocks or even options on ordinary stocks,
the true-up rules do not apply, and you can defer reporting the
income until you close the transaction.
-- 
Art Kamlet  a_s_kamlet@att.com  AT&T Bell Laboratories, Columbus