Naked Short Selling
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 â€œnakedâ€?
Why go naked? Naked short selling is now prohibited I am going to explain why it was so lucrative (Note â€“ 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!
The naked short has an incentive to stay short â€“ 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 â€“ on margin
So on his $150 million profit, he can trade abpout $300 million in stock
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 2008-9 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, 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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How to the Shorts Raid Your Stock, Destroy Your Company, and What to Do About It
Trader, investment banker, former OTC Market Maker and attorney – he is a former and possibly current short seller – but not naked
Copyright ©John Lux 2011
Published on Mar 20, 2011