They 'borrow' the stock from someone who has a long position and then you immediately sell it. Usually, if you tell your broker that you want to short a stock...he'll borrow that stock from someone who is long on that stock and lend it to you...you'll immediately sell that stock...hence selling something you don't own.

 
collegekid89:
How can someone sell a stock they do not own. I don't get it.

For example, what kind of asshat would purchase a house I don't own?

In buying a house the previous owner's relationship to that house might be of great importance (his/her experience, how they've treated the house, etc.) Obviously, an owner's relationship to a stock is irrelevant in the valution of that stock and, hence, even people who are not "asshats" would purchase stock from you that you've temporarily "borrowed" if the buyer feels that the stock will generate good returns on their investment.

There's a class that's usually a prerequisite for Finance 101, it's called Common Sense 101, you might want to look into it.

 

^^^Let me clarify, I don't mind you not knowing the details of some rather basic financial concepts, nobody will hold that against you, everybody has to learn at some time or another (though I would like for you to do more research on your own before you ask.) But the comparison of a stock to a house in the context of a transaction is just asinine.

 
rebelcross:
... But the comparison of a stock to a house in the context of a transaction is just asinine.

But the OP's use of the term "asshat" in that context was quite comical, you must admit.

 
Dr Joe:
rebelcross:
... But the comparison of a stock to a house in the context of a transaction is just asinine.

But the OP's use of the term "asshat" in that context was quite comical, you must admit.

lol, ok I'll give you that one

 

You borrow the stock from your broker and immediately sell it. So when you buy it back (or cover) to give the shares back to the lender, you earn/lose the amount the stock dropped/increased.

I hate it when people use the house analogy - I read an article on short-selling recently written by some bozo, the author wrote something like, "it's just not fair. I can't sell a house I don't own, so why should the fat cats on Wall Street be able to do that?!"

And the answer is, "Uhhh, you actually can sell a house you don't own....if someone lends it to you......"

 

I know what short selling is. You borrow shares of AAPL because you think its going to drop. Sell it. Buy it back when it does drop. and return the shares.

The definition of NAKED short selling mentioned selling what you don't have. I dont get that concept... Even in short selling you didn't "have" it. you just borrowed it?

 

first off all you are all wrong

NAKED short selling allows shares that are not tangiable to enter the market ....

you don't even borrow the stock that is why it is naked you pretty much make the promise to deliver a stock you say here you can have this but no tangiable stock is exchanged then you go and buy a stock THEN DELIVER THE TANGIABLE stock

/thread

 

short selling : you actually borrow stock and sell it naked short selling : you sell a stock that dosen't exist and pay with a stock that does exist

after i read my first post all i got out of what i said was i understood the word TANGIABLE

 

Whoever threw shit at this guy is an ass, honestly, naked shorting is an odd concept: most of the answers have concerned covered shorts. I drilled two finance professors to get an idea of how someone can sell something they have not borrowed in the first place.

Bastoise is dead on, the way I understand it is: naked shorts take advantage of the custom that trades do not have to be formally settled immediately, this allows selling shares you do not have/did not borrow, b/c you don't have to deliver for a few days; this has the potential to temporarily create shares, theoretically you could do this ad infinitum, putting a lot of downward pressure on a stock.

I'm personally not a fan of finance and economics analogies (house thing) – regardless its a valid question SB to anyone who can explain it in clear terms for the first time reader.

fdba Emory Blaine and BBA or otherwise trying to find the perfect pseudonym.
 
rebelcross:
@Emory Blaine False: From a buyer's perspective (which is what the OP asked), it makes absolutely no sense to compare a house to a stock. None whatsoever.

Dude, I didn't even consider the house thing – its not even the question, he was asking about naked shorts. My point is, its a valid question and he had shit thrown at him. And if you can relate it to a house, great.

fdba Emory Blaine and BBA or otherwise trying to find the perfect pseudonym.
 
Emory Blaine – fdba BBA:
rebelcross:
@Emory Blaine False: From a buyer's perspective (which is what the OP asked), it makes absolutely no sense to compare a house to a stock. None whatsoever.

Dude, I didn't even consider the house thing – its not even the question, he was asking about naked shorts. My point is, its a valid question and he had shit thrown at him. And if you can relate it to a house, great.

If you actually read the posts that followed you would see in one of my posts I said something along the lines of "nobody is bothered by the fact that you asked this question, it's ok not to know, but to compare a house to stock is asinine." Which is true, so I don't know what your outrage is about. Nobody thought it was a bad question (although he could've done some research.) It was the dumb comparison and arrogant use of "asshat" that was bothersome.

 
financialnewbie:
Okay I get it. You are basically lying that you have the stock. selling it. and a few days later having the transaction cancelled.

So in the end, what is the point of this. Creating "fake" shares temporarily. Does this drive the price of the stock down for a period of time?

Yes, temporarily and the transaction is canceled when the clearing house discovers that the stock is not there.

fdba Emory Blaine and BBA or otherwise trying to find the perfect pseudonym.
 
Addinator37:
One customer would create a synthetic long position by selling a put and buying a call at the same strike price. Once they did this, they would go and sell a deep in the money call in the same security. This creates a short position in the stock.
No it doesn't
 
NewGuy:
Addinator37:
One customer would create a synthetic long position by selling a put and buying a call at the same strike price. Once they did this, they would go and sell a deep in the money call in the same security. This creates a short position in the stock.
No it doesn't
From Addinator: " It's more of a technicality but you are short the shares because you owe them when you get assigned. You aren't technically short the shares in the sense that your hoping they go down you are short in the sense that you owe those shares on a stock that is already heavily in demand. What you are doing is establishing a "long" position and then selling the in the money call which makes you short that call (and theoretically the stock as you owe it). You are technically long the stock itself in the original synthetic position but short the shares in that you owe them to someone (the guy on the other side of the call you sold)"
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Addinator37: One customer would create a synthetic long position by selling a put and buying a call at the same strike price. Once they did this, they would go and sell a deep in the money call in the same security. This creates a short position in the stock. No it doesn't

I should clarify that. I mean short in the sense that you owe the shares to whomever took the other side of the call that you sold, which would theoretically be the same as being short the stock except you can't get the shares to deliver nor do you want to in this instance. If I sell a call I am short that option and theoretically short the stock. In this case it doesn't stay that way and gets assigned immediately as it is deep in the money. Then the buy-writes began happening to cancel out the fail to deliver issues.

 

The house wasnt a bad example... he was thinking like you can borrow an empty townhouse, sell it, and buy another townhouse a week later and return it to the owner. But how would you sell a townhouse that you don't have in the first place. Because the buyer would be like "dude wheres my house"

 
financialnewbie:
The house wasnt a bad example... he was thinking like you can borrow an empty townhouse, sell it, and buy another townhouse a week later and return it to the owner. But how would you sell a townhouse that you don't have in the first place. Because the buyer would be like "dude wheres my house"

Oh come on, some kind of contractual protection should have been a given.

 

Traders/hedge funds couldn't really naked short before. Before the process was the trader gets a locate on shares to borrow normally from a PB. The PB based the locate on a reasonable assumption that they could borrow the stock. Now the stock actually has to be borrowed.

I think this emergency order has basically caused a great deal of confusion, but really dose not do anything. Borrow rates may increase but people can still fairly easily short these names. Also, you can still make bearish bets with some derivatives (ie go long credit default swaps). This rule is fairly stupid. Large cap stocks like these names really don't need protection from short sellers. If a rumor is going to destroy these companies than there is already something deeply broken about the companies for a rumor to have that large of an impact.

www.sharpeinvesting.com

 

Naked shorts are used by traders since they are legally allowed to enter into these positions. They might have an option on the stock to purchase it at a set price and then "borrow" it in the mean time. Or, they might go totally naked and hope that the market moves in there favor. No need to send shit the OP's way.

looking for that pick-me-up to power through an all-nighter?
 

Question needs Clarity.

No. 1) are we talking about equity or future contracts?

No. 2) are those short held at B/D? If Yes than Cash would be the back up for a retail client, Clearing dpt usually hold % ratio of shares in the event if this occurs as back up deliverable " Not worth paying Transaction cost" ( Wont go into details- Google is God)

 

To clarify alot of the stuff posted here, I wanted to take a moment and break down a few of the key points.

First of all, in order to understand short selling, you need a basic understanding of Margin. In order to Short a Stock, the sale must be made in a Margin Account. Margin is basically a line of credit that you can use to gain leverage in your portfolio. Basically, Margin allows you to use whatever securities you hold in your portfolio as collateral to borrow against if you want to buy or sell securities. Certain trades, such as options and short selling require Margin accounts in order to provide collateral against your open trade. The thing is, when you put a security in your porfolio on Margin, you put up your securities as collateral and recieve a loan from your broker/dealer. Your Broker/Dealer is now a creditor and holds the securities as collateral against your loan. When the value of the collateral goes up, you get more money loaned to you. When the value of the collateral goes down, your borrowing power drops. When you get below a certain level, your broker/dealer can go ahead and ask you to cover your debt by asking you to sell securities in your portfolio, asking you to bring in cash to cover or, if you have exhausted all other methods to get money in to cover the drop in value, by going ahead and selling the shares you put up as collateral without your approval. The thing is, when you put securities up on Margin they can be loaned out via a Rehypothecation agreement written into the margin agreement. Rehypothecation allows for the collateral that you put up to be loaned out to other clients, creating a pool of stocks that can be used for shorting, among other things. Shares that are held on Margin are still considered to be part of the total shares outstanding since they can be accounted for.

With a short sale, you are using shares that are being rehypothetecated to sell shares you do not own. In order to prove that you can execute the Shore Sales, you or the executing trader are required to provide something called a Locate - a Short Sale Approval and Reference Number - in order to execute the trade. This is required because it says you now have X number of shares allocated until the end of the trading day to be used for a short sale and those shares will be used for the delivery of your trade.

Naked shorts are shorts made when you don't have a locate, meaning that you are selling shares that do not exist in the public markets. Say you have a security, XYZ, with 1MM shares available in the secondary markets. Of those 1MM shares, 250K are held on Margin and can be loaned out. If you wanted to short shares of XYZ, could not get a locate and went through with a short sale of 1,000 shares of the stock, you would have a naked short sale. The total outstanding shares is now increased by 1,000 to 1.001M despite there only being 250K worth of shares that are deliverable on marginable transactions. This sale had the unintended consequence of making the shares outstanding increase without new shares being issued. The naked seller has agreed to deliver shares that don't exist and are not accounted for on the open market to some buyer who will not immediately be recieving those shares.

Naked shorters have anywhere from 3 days to... I wanna say something like 21 days... to close the trade out depending on how long they want to take advantage of something called "Filing for Extention" under SEC Rule 15c3-3. The reason why I give an extended time frame is that under Rule 15c3-3, you can file for a brief reprieve to bring in capital. While I am a bit out of touch with the exact rules, if I recall correctly, you are allowed to file up to a total of 5 extentions per year starting from the first filed extention in order to delay reciept/delivery. So, say you execute a trade and end up being short cash on a buy order, you can file for extention if it takes longer than 3 days to get the funds in and your "Extention" calendar starts on that day and you can file for 4 more extentions between the date you filed your first and a year from that date. The same holds true for delivery of shares as well. Say you're selling, and you don't deliver on settlment, you can file for extention in order to provide a bit more time to get the shares in. However, the point is, you've now added more shares to the total shares outstanding without those shares actually being issued.

As to your point Libor, that's not entirely true.

Naked Shorting is still illegal, however there are some exemptions. Bona fide market makers, Broker/Dealers and those who fall under "NYSE Rule 200" - The Short Exemption Clause - can all be naked for a short period of time, however all trades must be made whole.

For broker dealers, there are a few smaller exemptions they get, but the most common is when you borrow from a firm other than the executing broker. Say I have a Prime Brokerage account at JP Morgan and am making a trade through the equities desk at Credit Suisse and I want to short shares of a stock, I can get a locate, or a Short Sale reference number saying I can short X number of available shares, from Credit Suisse (the firm executing my trade). If they don't have the shares and I still want to execute a short sale, I can reach out to my prime broker and see if they have shares to short instead. If JP Morgan has the shares, I can get a locate from them and provide it to the trader at Credit Suisse. The trade, despite having a locate attached to it, will be naked until the trade settles since CS does not have the shares to sell in the first place. When JP Morgan delivers the shares to CS on settlement date thanks to the locate they were provideded, CS can then deliver those shares out accordingly.

Bona fide Market Makers follow something similar. Because they are allowed to take both sides of the trade, they are able to go short or long in order to help make a market in any security they transact in. They are exempt from the Naked Short rule due to inventory and trading regulations.

NYSE Rule 200 is interesting, as it's the "Short Exemption" clause. Basically, this allows someone to enter into a naked sale of a stock pending reciept of shares. There are a few types of Short Exemptions, however the best example is when you have someone selling shares awarded by stock options or selling a restricted position via rule 10B5-1. They can enter into the trade naked on the promise of the shares being delivered under the auspises of cleaning the title on a Rule 144B security, Stock Options or other awards that may delay settlement. Rule 200 cases are also treated as an exemption for SEC Rule 15c3-3, as there is a restriction that legally allows for the temporary creation of a naked short.

 
Frieds:
To clarify alot of the stuff posted here, I wanted to take a moment and break down a few of the key points.

First of all, in order to understand short selling, you need a basic understanding of Margin. In order to Short a Stock, the sale must be made in a Margin Account. Margin is basically a line of credit that you can use to gain leverage in your portfolio. Basically, Margin allows you to use whatever securities you hold in your portfolio as collateral to borrow against if you want to buy or sell securities. Certain trades, such as options and short selling require Margin accounts in order to provide collateral against your open trade. The thing is, when you put a security in your porfolio on Margin, you put up your securities as collateral and recieve a loan from your broker/dealer. Your Broker/Dealer is now a creditor and holds the securities as collateral against your loan. When the value of the collateral goes up, you get more money loaned to you. When the value of the collateral goes down, your borrowing power drops. When you get below a certain level, your broker/dealer can go ahead and ask you to cover your debt by asking you to sell securities in your portfolio, asking you to bring in cash to cover or, if you have exhausted all other methods to get money in to cover the drop in value, by going ahead and selling the shares you put up as collateral without your approval. The thing is, when you put securities up on Margin they can be loaned out via a Rehypothecation agreement written into the margin agreement. Rehypothecation allows for the collateral that you put up to be loaned out to other clients, creating a pool of stocks that can be used for shorting, among other things. Shares that are held on Margin are still considered to be part of the total shares outstanding since they can be accounted for.

With a short sale, you are using shares that are being rehypothetecated to sell shares you do not own. In order to prove that you can execute the Shore Sales, you or the executing trader are required to provide something called a Locate - a Short Sale Approval and Reference Number - in order to execute the trade. This is required because it says you now have X number of shares allocated until the end of the trading day to be used for a short sale and those shares will be used for the delivery of your trade.

Naked shorts are shorts made when you don't have a locate, meaning that you are selling shares that do not exist in the public markets. Say you have a security, XYZ, with 1MM shares available in the secondary markets. Of those 1MM shares, 250K are held on Margin and can be loaned out. If you wanted to short shares of XYZ, could not get a locate and went through with a short sale of 1,000 shares of the stock, you would have a naked short sale. The total outstanding shares is now increased by 1,000 to 1.001M despite there only being 250K worth of shares that are deliverable on marginable transactions. This sale had the unintended consequence of making the shares outstanding increase without new shares being issued. The naked seller has agreed to deliver shares that don't exist and are not accounted for on the open market to some buyer who will not immediately be recieving those shares.

Naked shorters have anywhere from 3 days to... I wanna say something like 21 days... to close the trade out depending on how long they want to take advantage of something called "Filing for Extention" under SEC Rule 15c3-3. The reason why I give an extended time frame is that under Rule 15c3-3, you can file for a brief reprieve to bring in capital. While I am a bit out of touch with the exact rules, if I recall correctly, you are allowed to file up to a total of 5 extentions per year starting from the first filed extention in order to delay reciept/delivery. So, say you execute a trade and end up being short cash on a buy order, you can file for extention if it takes longer than 3 days to get the funds in and your "Extention" calendar starts on that day and you can file for 4 more extentions between the date you filed your first and a year from that date. The same holds true for delivery of shares as well. Say you're selling, and you don't deliver on settlment, you can file for extention in order to provide a bit more time to get the shares in. However, the point is, you've now added more shares to the total shares outstanding without those shares actually being issued.

As to your point Libor, that's not entirely true.

Naked Shorting is still illegal, however there are some exemptions. Bona fide market makers, Broker/Dealers and those who fall under "NYSE Rule 200" - The Short Exemption Clause - can all be naked for a short period of time, however all trades must be made whole.

For broker dealers, there are a few smaller exemptions they get, but the most common is when you borrow from a firm other than the executing broker. Say I have a Prime Brokerage account at JP Morgan and am making a trade through the equities desk at Credit Suisse and I want to short shares of a stock, I can get a locate, or a Short Sale reference number saying I can short X number of available shares, from Credit Suisse (the firm executing my trade). If they don't have the shares and I still want to execute a short sale, I can reach out to my prime broker and see if they have shares to short instead. If JP Morgan has the shares, I can get a locate from them and provide it to the trader at Credit Suisse. The trade, despite having a locate attached to it, will be naked until the trade settles since CS does not have the shares to sell in the first place. When JP Morgan delivers the shares to CS on settlement date thanks to the locate they were provideded, CS can then deliver those shares out accordingly.

Bona fide Market Makers follow something similar. Because they are allowed to take both sides of the trade, they are able to go short or long in order to help make a market in any security they transact in. They are exempt from the Naked Short rule due to inventory and trading regulations.

NYSE Rule 200 is interesting, as it's the "Short Exemption" clause. Basically, this allows someone to enter into a naked sale of a stock pending reciept of shares. There are a few types of Short Exemptions, however the best example is when you have someone selling shares awarded by stock options or selling a restricted position via rule 10B5-1. They can enter into the trade naked on the promise of the shares being delivered under the auspises of cleaning the title on a Rule 144B security, Stock Options or other awards that may delay settlement. Rule 200 cases are also treated as an exemption for SEC Rule 15c3-3, as there is a restriction that legally allows for the temporary creation of a naked short.

Thanks for this. Great post. My post was in reference to "Bona Fide Market Makers". In other words, these guys can trade naked shorts for the exact reasons you specified.

looking for that pick-me-up to power through an all-nighter?
 

The house analogy you use is wrong as well. Are you thinking a Real Estate short sale or asking about securities. If it's about securities, the house analogy is as follows:

I want to buy a house, so I buy it and take out a mortgage to help pay for it. When I take the mortgage, I place the house up as collateral, meaning that even though I "own" the house, the bank is now a creditor against the house. If I default on my mortgage, as the creditor, the bank can go ahead an sieze the collateral used to secure the mortgage, in this case my house, and do what they want with it in order to pay off the outstanding mortgage.

This is very similar to margin lending, which is one of the fundemental tenants of short trading.

 

The term "naked" is what he was asking about, not short selling. It is deemed a "naked" short sale because you have no way of covering your short position, meaning you have have no access to shares thus creating excess shares on the market. For example if your friend has a apple and you borrow that apple and sell it you have done a short sale. However if your friend has and an apple you borrow it and sell it yet you have a contract with another friend to sell you an apple at a predetermined price your short is "covered" in this case. If you sell an apple and you have no way of actually delivering that apple then you have done a "naked" short sale. The term "naked" is badly used in a situation like short selling. Since you cant have what is normally considered as a true cover which is owning the stock itself. Since FINRA regulations prevent someone from holding a long and short position in non deriverative equities i.e. stocks.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 

I gotta disagree with you Heister. He's asking about short selling. You're talking about options. Naked is an apt word for both and it describes two very different things. In options, being naked means you have no exposure to the underlying asset to pair with your option trade, but shorting an equity security is a different beast entirely. If I had shorted a security without a locate and write (sell) puts along side it, I would technically be covered. If I had a locate when I made the trade, I would also be covered. If I write puts alone without short exposure, I'm writing naked puts because I do not have the underlying security held short to be closed out by my expiring options and I'm planning on taking delivery on the shares.

In terms of Equity, naked has to do with the amount of shares available to borrow against, not long exposure. Naked, in the case of equities, will always be about delivery. Short selling is about the promise to deliver shares that you don't have on hand. This is why short selling requires you to provide a locate to prove that there are shares available to borrow from and deliver by settlement and that you are not selling on a promise to deliver. If you have ever delt with settling a trade, you can tell when a naked sale has gone through for the most part thanks to DF Notices. DF, or Delivery Failure, is exactly that, a notice that a trade isn't settling right because one party is not keeping up their end of the bargin, delivering the actual shares they are selling. It's one thing to DK (Don't Know) a trade saying that neither side knows it, but a DF indicates a bigger problem that delivery may not be made if the counterparty doesn't have the shares in question.

 
Frieds:
I gotta disagree with you Heister. He's asking about short selling. You're talking about options. Naked is an apt word for both and it describes two very different things. In options, being naked means you have no exposure to the underlying asset to pair with your option trade, but shorting an equity security is a different beast entirely. If I had shorted a security without a locate and write (sell) puts along side it, I would technically be covered. If I had a locate when I made the trade, I would also be covered. If I write puts alone without short exposure, I'm writing naked puts because I do not have the underlying security held short to be closed out by my expiring options and I'm planning on taking delivery on the shares.

In terms of Equity, naked has to do with the amount of shares available to borrow against, not long exposure. Naked, in the case of equities, will always be about delivery. Short selling is about the promise to deliver shares that you don't have on hand. This is why short selling requires you to provide a locate to prove that there are shares available to borrow from and deliver by settlement and that you are not selling on a promise to deliver. If you have ever delt with settling a trade, you can tell when a naked sale has gone through for the most part thanks to DF Notices. DF, or Delivery Failure, is exactly that, a notice that a trade isn't settling right because one party is not keeping up their end of the bargin, delivering the actual shares they are selling. It's one thing to DK (Don't Know) a trade saying that neither side knows it, but a DF indicates a bigger problem that delivery may not be made if the counterparty doesn't have the shares in question.

Thats true, I was pointing out that just because you have found shares to borrow doesnt mean you are truely covered from the exposure. At least thats what i was thinking about in my mind, sometimes I think one thing and something totally different comes out lol.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 
heister:
Thats true, I was pointing out that just because you have found shares to borrow doesnt mean you are truely covered from the exposure. At least thats what i was thinking about in my mind, sometimes I think one thing and something totally different comes out lol.

Then I'm going to ask you to clarify what you mean by "covered from the exposure", as I'm not sure you are using the terms right or I'm just reading what you are saying compeltely differently than I should.

 

What I am saying is that when you do a "naked" short you sell shares with out having found shares to borrow, thus increasing the total number of shares outstanding. If you do a non naked short sale you dont increase the number of shares but you are still exposed to upward movements. In order to hedge these movement and cover your exposure you have to use a call option at the price you sold the shares at when you borrowed them.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 

I hate to say this but what the hell are you talking about? You didn't answer my question and you aren't making any sense. Covered from the exposure to what? Downside risk? Upside gains? Why the hell are you using call options? What the hell do calls have to do with shorting stock and whatever the hell you meant by covering exposure? I'm scratching my head here trying to figure out what you mean.

 

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Dolor inventore iste fuga. Eius et numquam voluptatum suscipit non perferendis porro.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 

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Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne

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