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As I understand it, in the USA it is illegal to short (sell) an underlying asset without a counter-party that lends the asset (naked) for the sale. From the trader's perspective, why does it matter if the short is naked (aside from the problems with regulations)?

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    Shorts are worn to cover nakedness.... – Dilip Sarwate Feb 17 '18 at 15:33
  • @what country or exchange – Dheer Feb 17 '18 at 17:13
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The article in your link to Wikipedia explains naked short selling. Not much to add other than to try to put a few points in perspective.

First, let's consider borrow costs. From your link:

"The seller may also decide not to borrow the shares, in some cases because lenders are not available, or because the costs of lending are too high ... Studies have shown that naked short selling also increases with the cost of borrowing."

Here are the 5 most expensive hard to borrow stocks from my broker on 2/12/18. The next to last number is the annual borrow rate and the last number is the number of shares available to borrow.

NSPR INSPIREMD INC 504.25% 8000
FWDB MADRONA GLOBAL BOND ETF 112.90% 100
SNYFY SONY FINANCIAL HOLD-UNS ADR 108.84% 200
RSLS RESHAPE LIFESCIENCES INC 108.56% 300
MTWO ROOMLINX INC 130.61% 400

If someone chooses to circumvent borrowing, not only do they avoid these costs but they can manipulate share price. What happens to share price if there is more selling volume than buying volume? It drops. As price drops, investors with long positions may start to abandon their positions, accelerating the drop. If it's IBM with 900,000+ outstanding shares, maybe price is affected a little. Or not. But suppose it's a small cap stock? How would you feel as a holder of such long shares if that 'make believe' selling volume drove price down?

In addition, short sellers must pay the dividend if they are short the shares on the ex-div date. If the short selling is bogus, where does the buyer of those naked short sales get the dividend from? I imagine that there's a process for resolving it but I don't know who gets the short end of the stick or if/how it gets resolved, it certainly creates problems that no one wants to get enmeshed in.

Perhaps you can now see why naked short selling is illegal?

  • Bob, does your broker tell you how much of that 500% they will share #ith you if you were long the shares that are that tough to short? – JoeTaxpayer Feb 18 '18 at 20:08
  • Yep, my broker does provide the rebate info. With a borrow cost of 504.2464% on 2/12/18, their rebate rate is 502.8264%. I'm surprised that they are sharing such ill gotten gains so generously. :->) – Bob Baerker Feb 18 '18 at 21:05

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