One of the drawbacks of shorting stocks is that you inherit the obligation of paying the dividend. This can work against you in some ways but you can be prepared for it.
You heard me, everyone who did not know that you must pay the dividends when you short a stock now you do. But let’s look at why that is first. When you short a stock you borrow the stock from your broker who wants to keep it as a long term play and sell it to another investor on the open market.
The investor now owns the stock, but you owe the stock rights to your broker. This includes the dividends. When a company pays the dividends you have to pay the same amount to your broker.
Now I know many people are thinking, why would anyone want to take a position that will give them negative cash flow? Well in certain times it makes sense. This year the SPY has gone from $150 to $75 in a year, the $2.77 you would have got in dividends during that time would have done little to offset that. Likewise the $2.77 would have been a price any short seller would have been happy to pay.
Another thing you should remember, dividends are not extra money, and they come out of the stock price. If your stock is trading at $40 and you get a dividend of $1 your stock is now trading at $39. The change in price will often compensate the dividends you will have to pay as a short seller.
So do you even need to worry about dividends when shorting stocks? That depends on the trader, I do. Just to be safe, I prefer to look at how long I plan on holding the short position and how much it will cost in dividends. If a dividend is too much I will not short it.
To find out how I decide if a dividend is too much visit http://www.stocks-simplified.com/paying_dividends.html
For more information on the stock market visit http://www.stocks-simplified.com