Naked Short Selling
Disclaimer Stock speculation is very risky Do not trade with more than you can afford to lose. Seek professional investment advice. This is not investment advice. No warranties, you are on your own. This is not suitable for all investors
Naked Short Selling Defined Short sellers are supposed to borrow the stock they sold and deliver it to the buyer When the shorts do not bother to borrow the stock, they are “naked”
Why go naked? Naked short selling is now prohibited I am going to explain why it was so lucrative (Note – legitimate short selling serves a good function)
Negative Cash Flow Companies If a company has a negative cash flow, it needs to sell stock to raise money to survive Legitimate development stage and biotech companies often have negative cash flow If the shorts can push the stock down, the company cannot raise money and dies, giving the shorts a large profit
Naked Short Selling Naked shorts can push a company to zero stock price because they can sell unlimited amounts of stock If there are 10 million shares outstanding and the stock trades 50,000 shares per day, at a price of $10, the naked shorts can sell a million shares, driving the stock down, down, down If that isn't enough stock, more, more, more can be sold
The Naked Short Printing Press Naked shorts can sell MORE than the outstanding stock! Imagine a naked short selling 30 million shares of our hypothetical company that has 10 million shares outstanding If the short sells the 30 million shares at an average price of $5 and drives the stock to one cent, he has a profit of almost $150 million!
The Naked Short Printing Press If the short sells the 30 million shares at an average price of $5 and drives the stock to one cent, he has a profit of almost $150 million! But the market value of the entire company to begin with was only $100 million!
Taxes The naked short has an incentive to stay short – taxes When he closes the trade by buying back the stock, he has to pay about 1/3 of the gain in taxes. But if he keeps the trade open, his friendly broker will let him play with the almost all the profits – on margin So on his $150 million profit, he can trade abpout $300 million in stock
Pyramiding In this way, a naked short could pyramid his profits Take profits in the first stock and sell another $300 million short, etc. After a few trades like this, the profits are humongous
Naked Shorts Exposed If a naked short does not close out the trade, he definitely does not want the company to come back from the living dead, especially if he is using the money to destroy some other company If the stock comes back, he will lose heavily and the broker will ask him for more money to cover the margin on his short Thus, he will stop at nothing to hold the company down
Shorting the World Naked shorts were eventually outlawed If they pyramided their profits, they made huge gains in the market meltdown They would have had the money to attack large institutions, and eventually short whole countries All of this is hypothetical, naturally
Hypothetically Speaking Hypothetically speaking, there have been reports of stockholders being able to buy more than the outstanding common stock. Naked shorts were eventually outlawed I am investigating now one company that is alleging there is a short position of many times the outstanding stock
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John Lux Trader, investment banker, former OTC Market Maker and attorney – he is a former and possibly current short seller – but not naked gmail.com Copyright ©John Lux 2011