[arafa]

Please explain. I thought this was the whole purpose behind hedging, was to avoid the short squeeze. Are people reneging on the purchase agreements or overpromising? How can we know these aren't naked shorts and if so, why are they still facing the short squeeze?

[beervirus]

https://www.bloomberg.com/opinion/articles/2021-01-25/the-ga...

See footnote 3. "This does not necessarily mean a lot of people are doing evil illegal nefarious naked shorting! Really, I promise! There is no special limit on shorting at 100% of shares outstanding! Here is an explanation of how options market makers (discussed below) are allowed to short without a locate, but I want to offer an even simpler explanation. There are 100 shares. A owns 90 of them, B owns 10. A lends her 90 shares to C, who shorts them all to D. Now A owns 90 shares, B owns 10 and D owns 90—there are 100 shares outstanding, but190 shares show up on ownership lists. (The accounts balance because C owes 90 shares to A, giving C, in a sense, negative 90 shares.) Short interest is 90 shares out of 100 outstanding. Now D lends her 90 shares to E, who shorts them all to F. Now A owns 90, B 10, D 90 and F 90, for a total of 280 shares. Short interest is 180 shares out of 100 outstanding. No problem! No big deal! You can just keep re-borrowing the shares. F can lend them to G! It's fine."

[arafa]

Right, seems like a similar problem to banks and leverage. People can short more in aggregate than exists the same way the money multiplier exists for banks. But there are bank runs and it's built on trust, so that's risky too and we make people hold on to a certain amount to cover what they lend.

I guess I'd just prefer they use call options to cover the shorts instead of borrowing. No leverage or multiplier effect there. Gets too high, just execute the call. Am I also missing something there?

[FabHK]

So, first of all, the net shares outstanding are still 100. All the extra, whatever, 200 shorts are balanced out by 200 extra longs, and that creates obligations between them, which must be managed as usual (collateral, margin calls, risk limits, ...)

To short a share, you must borrow and sell it.

If you buy a call, you're long. You could write a call and then you'd have short exposure, indeed, but on the wrong side - you lose on the way up, while you want to win on the way down. So, you could buy a put - that makes you short, winning on the way down. However, now the entity that wrote the put is long, and will generally cover their exposure by - shorting. No magic bullet there.

[krok]

You can have a short squeeze without naked shorting. Shorts who aren't naked have borrowed the stock from someone. If that person asks for it back, they have to go out and buy it in order to return it.

At least in theory, if retail investors buy up the stock, some of the institutional investors who own it, and who have lent it out, will sell it to them. This could mean that they recall lent stock. As this happens, shorts might have to compete to buy the stock. Equally, as the price gets higher, shorts might have to cut their losses, which also means buying back the stock. If the people buying it now don't sell it and don't lend it they will withdraw a lot of the supply.

[oh_sigh]

Since you're nice and explaining things...what happens if a naked short gets called in but literally no one will sell any stock for any amount of money, so the shorter can't fulfill their obligation?

Obviously not going to happen with GME or anywhere realistically, but I'm just curious how that would be handled.

[krok]

Something called a Failure To Deliver. Basically you have to pay extra to keep the stock one more day or whatever, and you have to deliver it the next day, or next settlement period.

The fee could be quite punitive, or fairly trivial depending on the market. In some markets failure to deliver would be a very big deal and multiple could lead to some sort of disciplinary action. In other markets they might be commonplace for whatever technical reason, and everyone expects that they will happen, just tries to avoid them because of the fee.

There are various theories that in certain markets everyone fails to deliver all the time and it means that there isn't enough of whatever to meet all the obligations. I can't really comment on how much they make sense.

[arafa]

So it seems the issue is that people have borrowing agreements that can be recalled early (seems like it functions like a margin call in a way). Call it half-naked shorting, I guess. Still seems risky. I feel like they could've just bought call options and called it a day instead. Maybe that's too naive or call options are hard to find/pricey for Gamestop?

That still doesn't explain how you know folks aren't naked shorting. Maybe you can read the trades?

[krok]

I don't know they aren't, but it's illegal. Large hedge funds are unlikely to be breaking the law, and I haven't seen any evidence that they are which wasn't based on a misunderstanding of the free float numbers.

Stock borrowing is very very commonly done and renewed per-day, in the vast majority of situations this works fine.

[arafa]

I appreciate the explanations, thanks. I don't have the trading context. Seems like tail risk or Black Swan events yet again. I hope they made enough money on these shorts that it wasn't "picking up pennies in front of steamrollers". If not, then I wish there would be better rules to prevent the short squeeze, like requiring calls instead of stock borrowing (maybe this is too expensive). When the liability is theoretically infinite, it just seems really risky to count on the hope that you can keep borrowing the stock (which works great the vast majority of the time but every now and then you lose billions).