What happens with the "long" buyer of a stock when somebody else's short fails (that is, unlimited loss bankrupts short seller)

Question

I am a long buyer. That is, I buy and hold and essentially never let go (my profits come from dividends).

What happens when I buy a stock on the market that turned out to be somebody else's short, and that short fails when the the stock price rises so much the short seller cannot pay? I remember short selling has unlimited losses; I didn't short a company I could see was headed irrevocably towards bankruptcy because somebody was keeping them alive for political reasons (this caused their stock price to spike) and I would have no control to prevent the short from coming due in the middle of a 1-2 day spike where the value was 100x its typical value.

Answer 1

Unless I am missing something subtle, nothing happens to the buyer.

Suppose Alice wants to sell short 1000 shares of XYZ at $5. She borrows the shares from Bob and sells them to Charlie. Now Charlie actually owns the shares; they are in his account.

If the stock later goes up to $10, Charlie is happy; he could sell the shares he now owns, and make a $5000 profit.

Alice still has the $5000 she received from her short sale, and she owes 1000 shares to Bob. So she's effectively $5000 in debt. If Bob calls in the loan, she'll have to try to come up with another $5000 to buy 1000 shares at $10 on the open market.

If she can't, well, that's between her and Bob. Maybe she goes bankrupt and Bob has to write off a loss.

But none of this has any effect on Charlie! He got the shares he paid for, and nobody's going to take them away from him. He has no reason to care where they came from, or what sort of complicated transactions brought them into Alice's possession. She had them, and she sold them to him, and that's the end of the story as far as he's concerned.