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For the sake of argument, let's assume a scenario, where the company is very illiquid, and there are no shares for sale and even increasing the buy order doesn't produce sellers. What happens to the short seller, who wants to cover his short position in this scenario?

Or a second scenario: A company like Tesla goes private. The short sellers are not able to buy enough stock in time and they end up unable to cover their short positions.

Does something like this need to be settled between the lender and the shorter or is there a mechanism for this type of situation?

  • Their liability will continue to increase. There may also be penalty clauses – Valorum Aug 8 '18 at 10:12
  • @Valorum so they need to physically buy the share somehow or basically default on the lend? – user1721135 Aug 8 '18 at 18:56
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    I suspect that this story is similar to what you had in mind, a classic story of a "short squeeze"; telegraph.co.uk/finance/newsbysector/transport/3281537/… – Valorum Aug 8 '18 at 19:06
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    The very simple answer is that until you can exit the position, you'll be asked to regularly cover any losses with cash payments or other securities (Margin call). Eventually you'll go broke and your bankruptcy protects you from any further losses – Valorum Aug 8 '18 at 19:22
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Oh, he will find them. The question is AT WHAT PRICE. Short covering rallies are the worst and most brutal ones you have ever seen.

The investor may end up getting ridiculous executions and owing his broker a significant amount of money. Now...

Or a second scenario: A company like Tesla goes private. The short sellers are not able to buy enough stock in time and they end up unable to cover their short positions.

Ah, no. Basically they will be covered at the price it is taken private. You seem to assume they get stuck with a short for the rest of the universe - no, there are provisions for this.

  • So tesla going private is actually good for the shorts, as it caps their down side?! – user1721135 Aug 16 '18 at 10:37
  • Ah, tesla GOING private eliminates the shorts. Tesla trying to go is like any other takeover (which technically it is). If it fails - ouch. – TomTom Aug 16 '18 at 10:58
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As far as my understanding goes. This is the exact situation of a short squeeze. In general, whenever you want to buy an asset you need someone who is willing to sell it to you. The exact situation depends on the order type. With a limit order you simply wait until someone is willing to settle. With a marked order you would buy the shares to the next price someone is offering it. This can quickly push the price up (short squeeze).

However, short selling is often done with derivatives. In this case you get a so called margin call. You then need to transfer money to your Broker.

  • Short Squeeze is not applicable only to ill-liquid stocks. It is prominent is liquid stocks; where if the stock is doing well, the price goes up and if there are too many short positions, they will buy to cover short, this drives the price high and is cyclic till all the short positions are squeezed out. – Dheer Aug 10 '18 at 8:59
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If the shares are so illiquid that nobody ever trades in them, then there's little point in trying to short them in the first place. But if there is some trade going on, then the short seller has no choice but to keep raising the offer price until somebody decides that the offer is too good to miss.

Company privatisations are signalled well in advance, while short sellers work on a daily basis. But assuming that all the shares were being bought back at an agreed price, the short seller could compensate by paying the person who lent them the shares by that amount.

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