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I'm lost on the mechanics here, but doesn't this mean that any profit on the part of a short-selling customer was actually coming out of the pockets of GS? I m

I'm lost on the mechanics here, but doesn't this mean that any profit on the part of a short-selling customer was actually coming out of the pockets of GS? I mean...where does the money to cover the customer's profit on a naked short come from?

deleted 14y ago
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asmithmd1 14y ago
Come on, you know it was not coming out of GS pockets. It was a heads I win tales you lose situation. Evidently there is some amount of time between when a stock transaction is booked and when it clears - like a purchase made with a check. They were essentially writing bad checks by selling stock they didn't own. If the price of the stock went down, they would actually go out and buy the stock at the new lower price. If the stock went up they would say, sorry that stock transaction "failed" - darnedest thing, just happens sometimes. "Instead, he preferred to just sell stock he didn’t actually possess. That is what is meant by, “We want to fail them.” Trafaglia was talking about creating “fails” or “failed trades,” which is what happens when you don’t actually locate and borrow the stock within the time the law allows for trades to be settled."
- joe_the_user 14y ago
  And moreover, creating an apparent supply of the stock which didn't exist before would exert downward pressure on the stock (by supply-and-demand), hurting the holders of the company's shares. So he made the profit scenario more likely for himself.
- quantgenius 14y ago
  We want to fail them means we are going to issue a failure to deliver because it turns out that the stock we thought was available is not. If you fail on a trade, you don't cancel the trade, a trade is binding, it means you require the customer to buy the stock back to cover the short sale since the stock wasn't actually available. Since in this case the Goldman rep had told the client they could get the stock even though the client thought the stock was likely to be available, issuing a fail to deliver and requiring the client to buy the stock back would lead to egg on the face for whoever the client spoke to at Goldman. The other option for Goldman of course was to buy the stock to lend the customer and hedge out their risk maybe with a put option or to keep looking somewhere else for stock to borrow.
paperwork 14y ago
No, the profit doesn't come from GS. Say you think XYZ, currently priced at $100 is going to go down in price. You tell your broker (GS in this case) to short 1 share in the market. GS sells XYZ (someone else buys it) and you get $100 in your account while the quantity of XYZ shows up as -1. Later, the price does drop to $90. You tell GS to buy 1 share, and you pay $90 for that share. You now have $10 in your account ($100-$90) and the quantity of XYZ in your account it zero (-1 +1). Someone else in the market lost this money, you gained it. GS was supposed to have borrowed this 1 share from someone, but they didn't. In other words, for a short time, this 1 share was created out of this air. If there was a system to make sure that every single transaction was backed by an actual share, then this would not have been possible. However, transactions are not actually reconciled on a real-time basis. Someone with more knowledge of the back office will have to explain how such naked shorts can exist in books for longer than 3 days (perhaps GS was rolling over these shorts?)
- waterlesscloud 14y ago
  But if it's a naked short, the only transactions are between me and GS. I sell short at $100, GS gives me that $100. If there's no share behind that to sell, then they just gave me that $100 out of their own pocket, right? So then the stock drops to $90 and I cover my short by sending GS $90. There's still no real share to deal with. So GS gave me $100, had no source for that money other than their pockets, and I gave them back $90. They're down $10 of their own money. This can't be how it works or they wouldn't do it, and if they did, no one would be complaining. So how does it actually work?
  - refurb 14y ago
    I think the difference is that no money changes hands. Normal shorting is when you "borrow" a share from someone else with the promise of giving it back at a given date. You sell it and pocket the current price, then try and buy back the share in the future at a lower price, pocketing the difference. In reality, money never changes hands during a short (other than the cost of setting up the short). The short is only due at the end of the borrowing period (or before if a margin call happens). So in the case of a naked short, it's more of a bet on GS part. They don't located a share to "lend" you, they just say "ok, pay us a few dollars and you have a short". If the stock goes down, GS gives you the difference, if it goes up, you pay up. It's basically a bet and GS is the counterparty.

deleted 14y ago

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asmithmd1 14y ago

Come on, you know it was not coming out of GS pockets. It was a heads I win tales you lose situation. Evidently there is some amount of time between when a stock transaction is booked and when it clears - like a purchase made with a check. They were essentially writing bad checks by selling stock they didn't own. If the price of the stock went down, they would actually go out and buy the stock at the new lower price. If the stock went up they would say, sorry that stock transaction "failed" - darnedest thing, just happens sometimes. "Instead, he preferred to just sell stock he didn’t actually possess. That is what is meant by, “We want to fail them.” Trafaglia was talking about creating “fails” or “failed trades,” which is what happens when you don’t actually locate and borrow the stock within the time the law allows for trades to be settled."

joe_the_user 14y ago
And moreover, creating an apparent supply of the stock which didn't exist before would exert downward pressure on the stock (by supply-and-demand), hurting the holders of the company's shares. So he made the profit scenario more likely for himself.
quantgenius 14y ago
We want to fail them means we are going to issue a failure to deliver because it turns out that the stock we thought was available is not. If you fail on a trade, you don't cancel the trade, a trade is binding, it means you require the customer to buy the stock back to cover the short sale since the stock wasn't actually available. Since in this case the Goldman rep had told the client they could get the stock even though the client thought the stock was likely to be available, issuing a fail to deliver and requiring the client to buy the stock back would lead to egg on the face for whoever the client spoke to at Goldman. The other option for Goldman of course was to buy the stock to lend the customer and hedge out their risk maybe with a put option or to keep looking somewhere else for stock to borrow.

paperwork 14y ago

No, the profit doesn't come from GS. Say you think XYZ, currently priced at $100 is going to go down in price. You tell your broker (GS in this case) to short 1 share in the market. GS sells XYZ (someone else buys it) and you get $100 in your account while the quantity of XYZ shows up as -1. Later, the price does drop to $90. You tell GS to buy 1 share, and you pay $90 for that share. You now have $10 in your account ($100-$90) and the quantity of XYZ in your account it zero (-1 +1). Someone else in the market lost this money, you gained it. GS was supposed to have borrowed this 1 share from someone, but they didn't. In other words, for a short time, this 1 share was created out of this air. If there was a system to make sure that every single transaction was backed by an actual share, then this would not have been possible. However, transactions are not actually reconciled on a real-time basis. Someone with more knowledge of the back office will have to explain how such naked shorts can exist in books for longer than 3 days (perhaps GS was rolling over these shorts?)

waterlesscloud 14y ago
But if it's a naked short, the only transactions are between me and GS. I sell short at $100, GS gives me that $100. If there's no share behind that to sell, then they just gave me that $100 out of their own pocket, right? So then the stock drops to $90 and I cover my short by sending GS $90. There's still no real share to deal with. So GS gave me $100, had no source for that money other than their pockets, and I gave them back $90. They're down $10 of their own money. This can't be how it works or they wouldn't do it, and if they did, no one would be complaining. So how does it actually work?
- refurb 14y ago
  I think the difference is that no money changes hands. Normal shorting is when you "borrow" a share from someone else with the promise of giving it back at a given date. You sell it and pocket the current price, then try and buy back the share in the future at a lower price, pocketing the difference. In reality, money never changes hands during a short (other than the cost of setting up the short). The short is only due at the end of the borrowing period (or before if a margin call happens). So in the case of a naked short, it's more of a bet on GS part. They don't located a share to "lend" you, they just say "ok, pay us a few dollars and you have a short". If the stock goes down, GS gives you the difference, if it goes up, you pay up. It's basically a bet and GS is the counterparty.