[garethm]

The increase in supply is not caused by the final net position. It's in what you see when you look at the market.

Suppose there are 100k shares issued. Some traders decide to naked short 50k. Actual holders of the shares say, "Oh crap. Half the company is for sale - better dump my shares while I still can." So they put up a total of 75k for sale.

Now 50k of the 75k of actual shares need to be purchased by the people selling short, but if you look at the total number available for purchase at that point, you'll see 125k shares for sale - more than were ever issued.

Of course, this same issue can bite the short sellers in a "short squeeze". Suppose we own 60k of the shares in the company. If we see someone selling 50k, we know they are doing a naked short, and we should buy it. When we do, we will own 110% of the company. Obviously, to make things go to 100%, the short sellers need to buy the remaining 10% of the shares from you. You get to pick the price.

* Edited to add - you can see a recent example of a short squeeze in Volkswagen around October 2008: http://www.reuters.com/article/idUSTRE49R3I920081028

[danielsoneg]

Well, the problem is less that there are more shares of a company for sale than currently exist and more that it can generate high levels of unrealistic downward pressure on a stock. With a normal short sale, there is some balance between the long and short side - that is, you can only short so much before the longs start buying again and stop the downward price movement, and there are only so many people willing to lend stock to short. Once the supply is gone and the price is in balance, you can't continue to short the company and the downward price movement stops, theoretically having incorporated negative market sentiment.

With naked short sales, you're removing the supply restriction, making it possible to continue to pressure the stock downward beyond where it should go in a balanced market. This sort of pressure can cause a panic among investors in the company and become a self-fulfilling cycle - once a company's stock is pushed below a certain level, many investors will dump the stock, regardless of the fundamentals of the company. It's not a cheap maneuver, but it's potentially phenomenally profitable for the people committing the short, and it's totally devastating to the company under attack. It also doesn't represent balanced market sentiment, nor the actual value of the company, and the company can be forced to take dramatic measures due to circumstances for which it wasn't to blame. It's a potentially highly destructive practice and banned for a very good reason.

[jamesseda]

Moral equivalent is, If you knew a self employed guy needed to sell his boat to keep his mortgage current, and you bought similar boats and sold them below cost so the guy would go into foreclosure and then you bought his property.

[ewanmcteagle]

This is not the same. Once a company has sold stock it does not gain money from the ups and downs of the market. If it made agreements contingent on its stock maintaining a particular value then it has chosen a separate risk. A company cannot go out of business because its stock price is low. It can be bought by others but this also does not drive it out of business.

[pbhjpbhj]

>It can be bought by others but this also does not drive it out of business.

If the company is now worth $1 and owns anything of value then it's going to be bought and asset stripped. It may not actually be out of business when it gets run down by short sellers for their own profit but it's effect is going to be pretty much the same - unless there's suddenly a lack of greedy business prospectors :0)

I suspect that the company isn't really going to be able to raise new capital any longer either (or will find it very hard) but don't know enough to confirm that.

[danielsoneg]

Yeah, cost of capital is definitely a concern, for two reasons:

First, most companies fund new ventures via loans, etc., and the price of a company's stock and the company's overall valuation have a big impact on the terms a company can get on a loan - both how big a loan they can get and at what rate. Naked shorting materially worsens a company's ability to raise capital.

Second, most companies are operating on rolling credit lines - this is just a reality of doing business: Invoice Monday, get payment Wednesday, bills are due Tuesday. A company's stock dropping dramatically can cause these credit lines to be yanked, which can demolish otherwise solvent businesses.

[fexl]

These are great examples, and your point is well taken.

The https://loom.cc/faq system avoids this sort of nonsense altogether. An asset type such as 2fcb2b81bb96bb51cec88edcb4b9a480 might represent a real underlying asset being traded, but only the true issuer of that asset could create new units of it.

Anyone desiring to sell that asset short would have to create a brand new distinct asset type such as 6b17a53d425dbb15f933b98ace93e587. This new asset type would represent just that one individual's liability to pay back the original asset. So the new asset type would in effect be a simple loan contract.

With this approach, the supply of the original asset type 2fcb2b81bb96bb51cec88edcb4b9a480 remains completely unaffected, and nobody needs to panic.

[fexl]

I believe this is roughly how shorts are handled on the Lima stock exchange, through the mechanism of "Operaciones del Reporte" -- a peer-to-peer lending system on the exchange. These loans are fully collateralized, keeping the risk extremely low.

[parkan]

fexl, loom looks very interesting, and the maintainer (you?) actually touches up on some specific market-based ideas I've been sort of idly kicking around in the FAQ (e.g. phone service contract exchanges). Is there a way to get an invite/sponsorship to play around with the system?

[fexl]

Sure. I guess I could post it here, but maybe we could try hooking up at https://bonchat.org/9ff3842f90e90d5e with "katie tiny judd".

Or, more conventionally, visit the loom.cc web site and send an email from there (click Contact).

[steve19]

Please post and invite. I am sure many of us would like to try it.

[fexl]

7ae291850de6795268e019ee3e63c31a

[fexl]

taken

[fexl]

d302b24bb138e715e5c0cede42edd9f4

d9c48e12e7bf32fe3ce3410c4966b3bc

[fexl]

The d9c4 is retracted.

[fexl]

The d302 is taken.

[fexl]

afd4b44db6063e8a1286f9595c42822a

[fexl]

retracted

[fexl]

c1b1221342788225c1b60cd5d03a01a5

[steve19]

damn, I was to late. They have all been used. Sorry to be a PITA, but are you able to create a few more. Thanks.

[fexl]

taken

[fexl]

I have simplified the section titled "How do I use Loom to accept payments from customers on my web site?"

https://loom.cc/?function=faq#shopping

[cturner]

    Suppose there are 100k shares issued. Some traders decide
    to naked short 50k. Actual holders of the shares say, "Oh
    crap. Half the company is for sale - better dump my shares
    while I still can." So they put up a total of 75k for
    sale.

I used to believe that, and wrote to this effect in this forum previously. However, I've since been told that you can find out in Bloomberg how many shares are out short on some exchanges, even if they're naked. Hence, my previous statements suggesting that you could inflate stocks to lower prices are probably incorrect.