7 ms·

Summary: Every so often, someone gets very steamed about short selling, often with no real reason. Back in 2005, someone got very steamed about short selling,

by Lazare 6y ago

Summary: Every so often, someone gets very steamed about short selling, often with no real reason. Back in 2005, someone got very steamed about short selling, and then got a journalist to write a somewhat confused article about it. It's not clear anything was actually wrong then, but in any case, the rules have been changed a few times since then, so there doesn't seem to be any obvious relevance to current times. It's also worth noting that there's no real theoretical basis for why naked short selling would be harmful, no real empirical evidence showing it is harmful, no general laws against it, and the structure of the market allows and expects it to take place in some specific cases. If your mental model is that the stock market is a tool to allow people to trade a fixed number of concrete objects back and forth, this probably seems odd, but since that's not really a good model of how the stock market works or is intended to work, it's not clear that means much.

Tokelin 6y ago
What would be a better model for how the stock market works?
- dleslie 6y ago
  When it's not the purchase-a-thing model it's otherwise-disinterested third parties making large bets on possible future outcomes. It has more in common with a bookie's ledger than a warehouse of goods. Why this is often harmful and dangerous is that the financial viability of businesses and individuals are often backing these bets. A person or company expecting financing to be predictable and stable may suddenly find it not so because their lender is desperate to cover their gambling losses.
  - oblio 6y ago
    I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting. Except for a handful of folks, everybody loses money on them. The ones that do make money are rigging the game (à la casinos) or are just lucky. Some of the lucky ones have been lucky for decades, some even went bankrupt after being lucky for so long.
    - Lazare 6y ago
      > I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting. Imagine I run a chain of hotels in beach resorts. When tourism is up, I make a ton of money; when tourism is down, I lose a ton of money. I'd like to flatten this so I can make a steadier, safer stream of money, budget more sensibly, and not be at risk of going under if 2-3 bad years come in a row. What can I do? Well, maybe I look around and notice that a big spike in jet fuel prices drives ticket prices up, and when ticket prices go up people stay home and I lose money, whereas cheap jet fuel means high occupancy rates. So I might hedge by buying put options (and/or selling call options) on jet fuel. When fuel prices go up, I can offset my low revenues with cash from selling my now-valuable put options (or the cash I received earlier from selling now worthless call options). And when fuel prices go down, I can use some portion of my higher revenues to pay for the cost of the worthless puts I purchased (or to settle the now valuable calls I sold). This sort of thing is common and healthy, not just among end users, but even more so among intermediaries working to remove and reduce the amount of risk inherent in the system. Why are they not banned? Why would they be banned? > Except for a handful of folks, everybody loses money on them. That's not really how this works. Or indeed, could work.
      - swixi 6y ago
        This just seems like a complicated way to go about budgeting correctly. Save money when you have excess from increased revenues, and use that to cover yourself when revenues decrease. I don't understand what is gained by bringing puts into the equation, if they are just as cyclical as your revenues. And it seems to me that you'd need a decent understanding of what your budget should be in order to decide how much to spend on puts in the first place. What am I missing?
        harryh 6y ago
        Saving money requires keeping cash (sometimes a lot of it) in the bank that could otherwise be put to productive use. Options contracts allow offloading of risk without keeping this excess cash sitting there doing nothing. It can be much more capital efficient.
- Lazare 6y ago
  I don't have a good general answer; it's complex. But some specific things relevant to this story: Market makers are allowed and expected to run naked shorts in order to ensure liquidity. We want a system where you can just buy or sell an item "into the market", and then everything will get sorted out eventually. We optimise for the case where shares can be found because it's overwhelmingly common. Stock borrowing is routine and transparent. People often have no idea if their stock has been lent out or if they own a borrowed stock; the reason for this is because the system has been designed so it doesn't matter. Shorting is common and accepted. The volume of transactions is enormous, and the system began to freeze up under the weight of its own paperwork in the 60s and 70s. To work around this, a policy of stock immobilization was implemented to ensure that stocks don't need to physically change hands. As a result, almost all stocks in the US are actually owned by a small, obscure partnership called Cede & Co. As the excellent writer Matt Levine wrote a while back: > Nobody owns stock. What you own is an entitlement to stock held for you by your broker. But your broker doesn't own the stock either. What your broker owns is an entitlement to stock held for it by Cede & Co., which is a nominee of the Depository Trust Company, which is a company that is in the business of owning everyone's stock for them. This system sounds convoluted but actually makes it easy to keep track of things: If I sell stock to you, I don't have to courier over a paper share certificate, or call up the company and have it change its shareholder register. Our brokers just change some electronic entries at their DTC accounts and everything is cool. Dematerialization has been extremely helpful, but at scale, it moves us even further away from a system that deals with concrete items. Hence, eg, Levine's hilarious story "Banks Forgot Who Was Supposed to Own Dell Shares", from which my earlier excert comes from: https://www.bloomberg.com/opinion/articles/2015-07-14/banks-forgot-who-was-supposed-to-own-dell-shares#footnote-1436883540292 https://www.bloomberg.com/opinion/articles/2015-07-14/banks-... Or for another even more hilarious story (also by Levine), "Dole Food Had Too Many Shares": https://www.bloomberg.com/opinion/articles/2017-02-17/dole-food-had-too-many-shares https://www.bloomberg.com/opinion/articles/2017-02-17/dole-f... And so forth, and so on. The system, at every level, is not one where it makes any real sense to say "the company has issued five hundred thousand shares, I own twenty of them, I keep them in a drawer in my office, look, here are the serial numbers". It's more probabilistic than that, very much by design.
  - 6y ago
tempestn 6y ago
I think you could make an argument that allowing naked shorting could in fact be beneficial. Part of what's allowing gamestop stock to explode recently is that it's next to impossible to find shares to borrow for shorting. If everyone who wanted to short the stock could do so without having to borrow shares, price discovery might work significantly better. (I assume the counter-argument would be that short squeezes could be even more intense. But perhaps they would be less likely to occur in the first place.)
- twic 6y ago
  This is a reason why cash settled single-stock futures are useful. They have the same economic value as a long or short share of stock, but because they're just a bet on the price, they don't have any of the awkward features that come with needing to deliver an actual share.
- deleted 6y ago
  [deleted]
- jkhdigital 6y ago
  If stocks were synthetic assets then sure. But common stock represents an ownership share of a company, which is a collection of real physical things. Naked shorting means you’re basically allowing anti-stock, but there’s no such thing as “anti-ownership”. Stock, like hard money, should allow debit balances only.
- smabie 6y ago
  Really what you want in this case are just stock swaps or futures that are cash settled.
wcoenen 6y ago
> If your mental model is that the stock market is a tool to allow people to trade a fixed number of concrete objects back and forth, this probably seems odd, but since that's not really a good model of how the stock market works or is intended to work, it's not clear that means much. I'm pretty sure that's how the stock market is actually intended to work. This should be obvious if you consider things like dividends. There needs to be a fixed number of shares, each with a clear owner for that to work. The reason it's a bit more complicated in practice, is because historically the technology wasn't there to do realtime gross settlement. So to limit the number of transactions that the central database had to handle, layers of delayed net settlement were set up instead.
- harryh 6y ago
  I'm pretty sure that's how the stock market is actually intended to work. This should be obvious if you consider things like dividends. There needs to be a fixed number of shares, each with a clear owner for that to work. This isn't really true. Let's say a company has 100 shares and they decide to issue a $1 dividend. If there is no shorting, the company just pays out $100 and everything is done. But let's say there is shorting. Someone loans out 10 shares to a short who then sells them to someone else. All of a sudden there are 110 shares out there. So when the company pays out the $100 it's $10 short of what is required for each stockholder to get the dividend. So where does the required $10 come from? From the party shorting the stock of course! Anyone short a stock is required to pay out, in cash, any dividends issues while they hold a short position. So it all works out.
  - dingaling 6y ago
    So a company could discourage shorting of its stock by arranging dividends to be spread over the year? Paying out to 1/365th of shareholders each day for example.
    - harryh 6y ago
      You can't issues dividends to different shareholders differently (unless they have different classes of stock). All shares have identical rights.
theknocker 6y ago
I don't know what article you read, but this is a stupid ass "summary" of whatever you're trying to talk about. That aside, there are practices surrounding short-selling that represent clear COI. That this basic observation about reality should represent an unsophisticated view of the market's "purpose" is begging the question even aside from being wrong.
spiralx 6y ago
I'm pretty certain you can trace a lot of the current fervour over short-sellers to Elon Musk's ongoing paranoid rants about how they're evil and trying to ruin Tesla. There's likely a large crossover between WallStreetBets posters and Elon Musk fans.

by Lazare 6y ago

Tokelin 6y ago

What would be a better model for how the stock market works?

dleslie 6y ago
When it's not the purchase-a-thing model it's otherwise-disinterested third parties making large bets on possible future outcomes. It has more in common with a bookie's ledger than a warehouse of goods. Why this is often harmful and dangerous is that the financial viability of businesses and individuals are often backing these bets. A person or company expecting financing to be predictable and stable may suddenly find it not so because their lender is desperate to cover their gambling losses.
- oblio 6y ago
  I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting. Except for a handful of folks, everybody loses money on them. The ones that do make money are rigging the game (à la casinos) or are just lucky. Some of the lucky ones have been lucky for decades, some even went bankrupt after being lucky for so long.
  - Lazare 6y ago
    > I still don't understand why these kinds of derivatives are not banned. They're, as you described, basically betting. Imagine I run a chain of hotels in beach resorts. When tourism is up, I make a ton of money; when tourism is down, I lose a ton of money. I'd like to flatten this so I can make a steadier, safer stream of money, budget more sensibly, and not be at risk of going under if 2-3 bad years come in a row. What can I do? Well, maybe I look around and notice that a big spike in jet fuel prices drives ticket prices up, and when ticket prices go up people stay home and I lose money, whereas cheap jet fuel means high occupancy rates. So I might hedge by buying put options (and/or selling call options) on jet fuel. When fuel prices go up, I can offset my low revenues with cash from selling my now-valuable put options (or the cash I received earlier from selling now worthless call options). And when fuel prices go down, I can use some portion of my higher revenues to pay for the cost of the worthless puts I purchased (or to settle the now valuable calls I sold). This sort of thing is common and healthy, not just among end users, but even more so among intermediaries working to remove and reduce the amount of risk inherent in the system. Why are they not banned? Why would they be banned? > Except for a handful of folks, everybody loses money on them. That's not really how this works. Or indeed, could work.
    - swixi 6y ago
      This just seems like a complicated way to go about budgeting correctly. Save money when you have excess from increased revenues, and use that to cover yourself when revenues decrease. I don't understand what is gained by bringing puts into the equation, if they are just as cyclical as your revenues. And it seems to me that you'd need a decent understanding of what your budget should be in order to decide how much to spend on puts in the first place. What am I missing?
      - harryh 6y ago
        Saving money requires keeping cash (sometimes a lot of it) in the bank that could otherwise be put to productive use. Options contracts allow offloading of risk without keeping this excess cash sitting there doing nothing. It can be much more capital efficient.
Lazare 6y ago
I don't have a good general answer; it's complex. But some specific things relevant to this story: Market makers are allowed and expected to run naked shorts in order to ensure liquidity. We want a system where you can just buy or sell an item "into the market", and then everything will get sorted out eventually. We optimise for the case where shares can be found because it's overwhelmingly common. Stock borrowing is routine and transparent. People often have no idea if their stock has been lent out or if they own a borrowed stock; the reason for this is because the system has been designed so it doesn't matter. Shorting is common and accepted. The volume of transactions is enormous, and the system began to freeze up under the weight of its own paperwork in the 60s and 70s. To work around this, a policy of stock immobilization was implemented to ensure that stocks don't need to physically change hands. As a result, almost all stocks in the US are actually owned by a small, obscure partnership called Cede & Co. As the excellent writer Matt Levine wrote a while back: > Nobody owns stock. What you own is an entitlement to stock held for you by your broker. But your broker doesn't own the stock either. What your broker owns is an entitlement to stock held for it by Cede & Co., which is a nominee of the Depository Trust Company, which is a company that is in the business of owning everyone's stock for them. This system sounds convoluted but actually makes it easy to keep track of things: If I sell stock to you, I don't have to courier over a paper share certificate, or call up the company and have it change its shareholder register. Our brokers just change some electronic entries at their DTC accounts and everything is cool. Dematerialization has been extremely helpful, but at scale, it moves us even further away from a system that deals with concrete items. Hence, eg, Levine's hilarious story "Banks Forgot Who Was Supposed to Own Dell Shares", from which my earlier excert comes from: https://www.bloomberg.com/opinion/articles/2015-07-14/banks-forgot-who-was-supposed-to-own-dell-shares#footnote-1436883540292 https://www.bloomberg.com/opinion/articles/2015-07-14/banks-... Or for another even more hilarious story (also by Levine), "Dole Food Had Too Many Shares": https://www.bloomberg.com/opinion/articles/2017-02-17/dole-food-had-too-many-shares https://www.bloomberg.com/opinion/articles/2017-02-17/dole-f... And so forth, and so on. The system, at every level, is not one where it makes any real sense to say "the company has issued five hundred thousand shares, I own twenty of them, I keep them in a drawer in my office, look, here are the serial numbers". It's more probabilistic than that, very much by design.
- 6y ago

tempestn 6y ago

I think you could make an argument that allowing naked shorting could in fact be beneficial. Part of what's allowing gamestop stock to explode recently is that it's next to impossible to find shares to borrow for shorting. If everyone who wanted to short the stock could do so without having to borrow shares, price discovery might work significantly better. (I assume the counter-argument would be that short squeezes could be even more intense. But perhaps they would be less likely to occur in the first place.)

twic 6y ago
This is a reason why cash settled single-stock futures are useful. They have the same economic value as a long or short share of stock, but because they're just a bet on the price, they don't have any of the awkward features that come with needing to deliver an actual share.
deleted 6y ago
[deleted]
jkhdigital 6y ago
If stocks were synthetic assets then sure. But common stock represents an ownership share of a company, which is a collection of real physical things. Naked shorting means you’re basically allowing anti-stock, but there’s no such thing as “anti-ownership”. Stock, like hard money, should allow debit balances only.
smabie 6y ago
Really what you want in this case are just stock swaps or futures that are cash settled.

wcoenen 6y ago

> If your mental model is that the stock market is a tool to allow people to trade a fixed number of concrete objects back and forth, this probably seems odd, but since that's not really a good model of how the stock market works or is intended to work, it's not clear that means much. I'm pretty sure that's how the stock market is actually intended to work. This should be obvious if you consider things like dividends. There needs to be a fixed number of shares, each with a clear owner for that to work. The reason it's a bit more complicated in practice, is because historically the technology wasn't there to do realtime gross settlement. So to limit the number of transactions that the central database had to handle, layers of delayed net settlement were set up instead.

harryh 6y ago
I'm pretty sure that's how the stock market is actually intended to work. This should be obvious if you consider things like dividends. There needs to be a fixed number of shares, each with a clear owner for that to work. This isn't really true. Let's say a company has 100 shares and they decide to issue a $1 dividend. If there is no shorting, the company just pays out $100 and everything is done. But let's say there is shorting. Someone loans out 10 shares to a short who then sells them to someone else. All of a sudden there are 110 shares out there. So when the company pays out the $100 it's $10 short of what is required for each stockholder to get the dividend. So where does the required $10 come from? From the party shorting the stock of course! Anyone short a stock is required to pay out, in cash, any dividends issues while they hold a short position. So it all works out.
- dingaling 6y ago
  So a company could discourage shorting of its stock by arranging dividends to be spread over the year? Paying out to 1/365th of shareholders each day for example.
  - harryh 6y ago
    You can't issues dividends to different shareholders differently (unless they have different classes of stock). All shares have identical rights.

theknocker 6y ago

I don't know what article you read, but this is a stupid ass "summary" of whatever you're trying to talk about. That aside, there are practices surrounding short-selling that represent clear COI. That this basic observation about reality should represent an unsophisticated view of the market's "purpose" is begging the question even aside from being wrong.

spiralx 6y ago

I'm pretty certain you can trace a lot of the current fervour over short-sellers to Elon Musk's ongoing paranoid rants about how they're evil and trying to ruin Tesla. There's likely a large crossover between WallStreetBets posters and Elon Musk fans.