Enforcement method of short contract

Question

A stock short seller promises to pay back a stock at a certain date, but what is the mechanism that actually forces them to buy the stock?

I've read that it is the broker who will do a margin call and buy the stock for them, but that seems only to redefine the question, since the broker is then forced to buy the stock.

Lets say you have a contract for shipment of an item. The seller promises to deliver in 7 days, but you need to write into the contract "WHAT IF" sections for if the seller neglects to do so, for whatever reason. That could be fees, penalties, etc.

So, say the short seller (or broker, or whoever) neglects to purchase the stock, do they owe the other party "all their money", "the price of the stock at a certain instant", "penalties/interest for the X days the stock is not purchased (until bankruptcy of the short seller)"?

Answer 1

There is no contract when someone shorts a stock in U.S. market nor does he have to pay back a stock at a certain date.

In the U.S. Reg T margin for shorting is effectively 50% of the dollar amount shorted. The minimum margin requirement MMR is 30% (equity divided by position value). Brokers can require more margin than Reg T. There are two reasons that force a short seller to buy back the stock:

1. The loaner of the shares chooses to sell them. The borrower's broker is notified that the shares must be returned. The borrower's broker looks for replacement shares. If he cannot find any, the short seller is given a forced buy in notice and must buy-to-close shares by 4 PM. If he does not, the broker will do so (not advisable because prices are less favorable during the after market).

2. The other reason why a short seller is forced by his broker to close his short position is failure to maintain sufficient margin. If on Reg T MMR of 30%, you have about 15% of buffer (price rise) before you reach the MMR. After that, you must deposit $1.30 of cash or marginable securities for every dollar the equity rises.

So for example, if you short 100 shares at \$20. A bit above \$23, you'll need to add more margin. After that, for every \$1 that the stock rises, you'll need another \$130 of margin in your account to keep your short position open. This becomes more of a problem if your broker raises its margin rate as some did before the November election as well as this past week when they raised it for GameStop.

The short interest accrues daily and is based on the daily borrow rate times the closing price of the stock. It contributes to the cash drain when a short position is moving against you but it is only a small factor compared to the margin issue if share price is rising.