What Happens If a Stock That I am Short Goes Bankrupt?

This is a common question that I often here from people that short-sell. What happens if a stock that I am short gets halted and announces their bankruptcy?

First off, as a short-seller, this is your ideal scenario. Nothing says "worthless common stock" better than a bankruptcy. The only downside to being short a stock that announces its bankruptcy is that your money can be tied up for a little while. Companies don't just announce they are going bankrupt out of the blue; they are always many warning signs, so if you are already up huge on your short position and the stock is trading for pennies, you may want to cover your position and move on.

If you are still short when the stock announces its bankruptcy, here is what will usually happen. The stock will announce that it is going bankrupt and the shares will halted. You will obviously not be able to cover your position in the stock at this time. The stock will then be delisted from whatever stock exchange that it is trading on. Considering that common shareholders are the last to receive anything in the case of a bankruptcy, you can pretty much safely assume that if the stock does eventually emerge from bankruptcy, the current common shareholders will receive nothing. More often than not, the company will just disappear, selling assets off to pay off creditors.

Eventually, your stock broker will mark the position down to zero (meaning that the value of the common stock in their eyes is nothing) and you will be able to cover your short position for a 100% gain. As I said though, this can take a while, so you may want to cover your position when you have the chance and move on if you don't want to wait.

Filed under: Stock Market Education | General Knowledge