Fees Involved In Long & Short Trading

By: ispeculatornew
Date posted: 05.30.2011 (5:00 am) | Write a Comment  (0 Comments)

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A couple of weeks ago, we received a question by email (we always like to receive them,  drop here if you have your own) relating to our long & short trading. The reader has been executing some of our most recent trades and was being hit with a 2.6% annual fee for being short Blue Nile (NILE). He was wondering if those fees were being included in our performance data.  It’s a great question and I should have actually written about this earlier but here it goes. The short answer is NO.

Why Are Fees Not Included In Your Performance?

The most important reason is that those fees are not “significant” and they would be so drastically different from one investor to the other. That being said, I think it’s important for me to explain what those fees are because while it is difficult to publish this data here, it does remain something very important to investors. I will add a link to this post on the page where we publish all of our returns for future reference.

Fees and Revenues Breakdown

The long & short trading that we perform here involves two major types of fees as well as a revenue that you might not realize that you have. Imagine that you perform a trading going Long Apple (AAPL) and Short Blue Nile (NILE). What are the fees involved?

  • Execution Costs: Trading stocks will always cost you but the fee depends largely on which broker you use. Some will charge $30 per trade while others will charge much less than $5. It also depends on the number of shares you are buying. Are these costs significant? It all depends not only on your broker but also on the amount you are trading. How significant is a $5 trading fee when you are trading $10,000? It represents 0.20% (5$ for each side, both on the entry and exit). However, if you are paying more in commissions or are trading a much smaller notional, the trading costs can become more significant.
  • Borrowing Fees: When you short a stock, you must get a prior borrow of that stock from your broker (in the US those rules are fairly strict). Why? Because if you sell a stock that you do not own, how will you deliver them to the buyer? The answer is that your broker will borrow the shares. Those fees are much more significant. The reader was being charged a 2.8% fee to borrow Blue Nile which is certainly significant. The issue of course is that the borrowing costs will be drastically different from one broker to another. You end up paying the borrow cost until you buy back the shares that you shorted. That can end up costing you between 1-5%. I usually stay away from the most expensive names but a stock like Blue Nile will end up being shorted quite a bit (usually with good reason!).
  • Interest on Cash: The other part of that equation is that you receive interest on your cash. Why? Because if you have a $10,000 portfolio and do long & short trades, you will end up with more or less the initial $10,000 in your account (the money cancels itself out in the long & short trades). The hope is that the interest received on that money will be enough to compensate to a large extent for your borrowing fees. Depending on the stocks and the rate that you are receiving that may or may not be the case.

Transparency

It would be very difficult for me to estimate the fees that investors would typically pay on our trading. For that reason, we prefer to present our return “before fees.” We will make sure this is written more explicitly in the future. If I were to estimate the costs, I would say that they should be between 2-3% of your notional at any time which seems reasonable given our current record.

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