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I know that if you short a stock you borrow it from a broker, immediately sell it, and then buy it back at (hopefully) a lower price.

But I don't understand how it impacts the leverage of a portfolio. E.g.,

Suppose you have a \$100 initial capital, and ABC is trading at \$10 per share. If you decide to short 5 ABC shares, what would the leverage of your new portfolio be?

I would be grateful for any help/ explanations.

Thanks

Jack

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  • $\begingroup$ Shorting an asset is akin to borrowing money. A related question is, how does borrowing money impact the leverage of a portfolio? $\endgroup$
    – Matthew Gunn
    Commented Jan 19, 2018 at 22:11

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One way of looking at it is how much stock is in your control.

The calculation that I have seen most frequently in Long-Short portfolios for the leverage calculation is (Longs + Shorts)/Equity.

In your example, assuming the $100 is invested in a long position:

($100 Long + $$50 Short) / $100 = 1.5 or 150%

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    $\begingroup$ The statistic that you describe is sometimes called gross leverage fool.com/knowledge-center/… You can also calculate net leverage by putting a minus sign in front of the short position value. $\endgroup$
    – Alex C
    Commented Jan 20, 2018 at 0:38
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Leverage depends on the security you are shorting and what your brokerage will offer. Typically for retail investors leverage will be lower (2-4x). For institutional clients a brokerage can offer significantly higher leverage. Also it will depend on the security, generally speaking leverage is higher on low volatility assets which are highly liquid. Meanwhile leverage offered by a brokerage will be lower if the asset is highly iliquid and volatile.

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