What Happens to Shorted Shares in a Bankruptcy?

What Happens to Shorted Shares in a Bankruptcy?

In this edition of The Motley Fool's "Ask a Fool" series, Motley Fool One analyst Jason Moser and Motley Fool Stock Advisor analyst Brendan Mathews take a question from a reader who asks: "A hypothetical company goes out of business, and its stock becomes worthless. Would that also be bad to the people that shorted the stock?"

Brendan explains shorting: When you short a stock, you borrow shares from your broker and sell them. So you have cash, but you also have an obligation to return the shares that you've borrowed at some point. That means you need to buy back the shares at some point. If the value of the shares declines, then you can buy back at less than you previously sold - so you will have made a profit. If the shares become totally worthless, you won't need to buy back the shares, and the short-seller will have made a 100% profit.

See more in the following video.

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The article What Happens to Shorted Shares in a Bankruptcy? originally appeared on Fool.com.

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Originally published