How Shorting Bankrupt Stocks Works in 2025: Risks, Rewards, and Key Insights

Gordon Scott, a Chartered Market Technician (CMT) with over 20 years of experience in investing and technical analysis, shares expert insights.

What occurs when an investor holds a short position in a company that becomes delisted and files for bankruptcy? Simply put: the investor is not obligated to repay anything because the shares become worthless.

Bankruptcies can happen suddenly or gradually. If a short seller hasn't covered their position before trading halts, they might need to wait until the company is liquidated to realize profits.

Fortunately for short sellers, they owe nothing after bankruptcy. Eventually, brokers will write off the loaned shares as a total loss, cancel the debt, and return any collateral.

Essential Points to Remember

• Short sellers who don’t close their positions before bankruptcy may have to wait for liquidation but never owe repayment.
• Short selling is enabled by brokerages, not the companies themselves.
• Profits come from borrowing shares, selling them at a high price, then repurchasing at a lower price.
• Due to high risks, short selling is generally avoided by most individual investors.

Why Are Stocks Available for Short Selling?

Short selling sparks questions: How can investors short stocks? Don’t companies protect shareholder value? Why don’t companies prevent short selling that might hasten bankruptcy?

Often, struggling management blames short sellers. Some governments have temporarily banned short selling during crises, like the EU’s move during the 2020 coronavirus pandemic.

However, companies cannot usually stop brokerages from allowing short sales. It’s important to note that brokerages, not companies, permit short selling. No company welcomes short sellers.

Governments allow short selling because it provides valuable market information. Bears help deflate bubbles by selling overvalued stocks and later buying shares, which can stabilize markets after crashes.

Understanding the Mechanics of Short Selling

Short selling involves borrowing shares, selling them immediately, and later buying them back to return to the lender.

For example, if an investor shorts one share of ABC Bank at $100 and the price drops to $70, buying back the share nets a $30 profit.

Short sellers add liquidity and prevent irrational price surges. Buying back to close a short position is the only exit unless the company goes bankrupt.

The High Risks of Short Selling

Despite market benefits, short selling is risky and unsuitable for most retail investors. Losses can be unlimited since stock prices can soar infinitely above the short sale price.

In practice, brokers issue margin calls to limit losses. Yet, sudden price jumps can wipe out accounts overnight, forcing investors to add funds or close positions.

Pro Tip

Facing a margin call, short sellers are usually better off closing their positions.

Conversely, buying stocks limits losses to the initial investment, making it a safer strategy than short selling.

Case Study: The 2023 SVB Collapse and Short Sellers

Silicon Valley Bank’s rapid downfall exemplifies a short seller’s potential gains and challenges.

SVB invested heavily in long-term U.S. government bonds, which lost value as interest rates rose sharply. Customer withdrawals forced SVB to sell bonds at losses, triggering a bank run.

Investors betting against SVB saw shares plummet 60%, earning approximately $513 million in one day. However, after the FDIC seized the bank and halted trading, short sellers couldn’t immediately close positions.

Eventually, brokers acknowledged the profits, but short sellers continued incurring borrowing costs during the trading freeze.

Important Insight

When a shorted stock goes bankrupt, the investor’s prediction is correct. The downside is waiting longer to collect profits and managing ongoing borrowing fees.

What Happens When You Buy Stock in a Bankrupt Company?

If you hold shares in a bankrupt company, the stock typically becomes worthless, resulting in total loss.

What If You Short a Stock and It Rises?

If the stock price rises beyond your account’s liquidation value, you’ll receive a margin call requiring additional funds or forced position closure.

Do Short Sellers Often Lose Money?

Yes, short selling is inherently risky because stock prices can rise without limit, causing potentially massive losses.

Final Thoughts

Short sellers profit by borrowing shares, selling them, and repurchasing at lower prices, aiming to benefit from declining stocks.

When a company stops trading due to bankruptcy, short sellers don’t need to buy back worthless shares. Brokers then cancel the debt and return collateral, completing the process.

Explore useful articles in Stock Trading as of 21-03-2023. The article titled " How Shorting Bankrupt Stocks Works in 2025: Risks, Rewards, and Key Insights " offers in-depth analysis and practical advice in the Stock Trading field. Each article is carefully crafted by experts to provide maximum value to readers.

The " How Shorting Bankrupt Stocks Works in 2025: Risks, Rewards, and Key Insights " article expands your knowledge in Stock Trading, keeps you informed about the latest developments, and helps you make well-informed decisions. Each article is based on unique content, ensuring originality and quality.