How to borrow shares from a broker?
Traders and Investors enter the stock market with the ultimate goal of making profits. The financial entities that deal in the stock market have created a system where the investor can lend or borrow shares from the stockbroker and make profits without actually selling or buying shares, respectively. The process, called Securities Lending and Borrowing, allows the trader to make quick profits without holding the shares in the Demat account for long.
This blog will help you understand the borrowing part of the system and how to borrow shares from a broker to make quick and hefty profits.
What is Stock Lending and Borrowing?
Stock Lending and Borrowing (SLB) is a financial system where traders or investors can lend or borrow shares. Under the system, traders or investors can borrow shares from brokers they do not own and can lend the shares their own to the brokers they do not want to sell immediately. However, Investors and brokers can only do SLB transactions for the stocks that are a part of the Futures and Options segment.
How does the Borrowing Shares from the broker work?
Traders borrow shares from brokers to make a profit based on the price difference between the borrowing price of the shares and the price at which the shares are sold. However, in the stock market, the share price doesn't have to always rise to allow traders who borrow shares to make a profit. By borrowing shares, traders can make profits in both scenarios; if they anticipate the share price to go down or if they think the share price will go up.
If the trader thinks the share price will fall: In such a case, traders borrow shares from brokers for a process known as short selling. Under the process, the traders approach the brokers to borrow shares that are immediately sold in the open market.
For example, a trader borrows 1,000 shares of ABC priced at Rs 500 from the broker. Just after borrowing the shares, the trader sells the shares in the open market at Rs 500 and realises Rs 5,00,000. As the broker allows the borrowing for a predetermined tenure, it also charges an interest rate. At the end of the tenure, or before, the share price falls to Rs 300. The trader then buys 1000 shares at Rs 300 from the open market and gives back the 1000 shares to the broker along with the interest amount. The process allowed the trader to make Rs 2,00,000 minus interest as profits without actually owning the shares.
If the trader thinks the price will rise: This is where traders borrow shares if they think the share price will rise. The process sees the trader borrowing shares from the broker without actually holding them. The broker holds the shares for the specified tenure, where the trader has to provide interest for borrowing the shares. For example, a trader borrows 1000 shares priced at Rs 500 currently. The broker holds the shares for a predetermined tenure and in return for interest. Suppose the share price rises to Rs 700; the trader then instructs the broker to sell the shares and deduct the interest. The rest of the amount, i.e. Rs 2,00,00 minus interest is paid to you by the broker as profits.
Borrowing as a Trader
Although traders borrow shares from brokers, the process requires keeping a minimum cash amount in the brokerage account as a margin. This margin amount serves as collateral to assist brokers in case the anticipation of the trader becomes unfavourable. For example, the share price may rise when the shares are borrowers for short selling, forcing the investor to incur losses. However, as the shares are not owned by the trader, the broker is responsible for balancing the losses and giving back the shares to the original owner.
Rate of Interest on Borrowed Stocks
Borrowing shares also comes with an interest rate set by the brokerages and the trader is legally bound to provide the interest payment to the broker for rendering the borrowing shares service. The interest rate is fixed by the brokers and varies depending on the number of shares and the tenure of borrowing shares. Mostly, the interest rate is calculated on a per-month basis by the broker. Furthermore, the interest rate also depends on the stock’s price on the day the trader borrows shares from the broker.
Borrowing stocks can be an effective way to make quick profits without buying shares using your own money. If you can anticipate the price direction of a particular stock, whether to be positive or negative, you can make profits by borrowing shares from the broker. However, it is vital to do extensive stock research before borrowing shares and analyse the risks associated with the process. Once you have, you can contact your broker to borrow stocks and make good profits.