Why has short selling suddenly become a hot topic

Short selling can be controversial, especially among the management teams of companies whose stock traders are betting that their prices will fall. And a fresh spike in allegations of “naked short selling” among microcap stocks is angering some management groups to the point of threatening legal action:

Hold a long position means buying a stock and holding it, expecting the price to go up.

shortenor short, is when an investor borrows stocks and sells them immediately, hoping they can later buy them back at a lower price, pay the lender back, and pocket the difference.

cover is when an investor with a short position buys back shares to close the short position and return the stock to the lender.

If you hold a long position, you may lose all your money. A stock can go to zero if a company goes bankrupt. But a short position is riskier. If the stock price rises steadily after an investor makes a short sale, that investor is suffering an unrealized capital loss. This is why short selling has traditionally been dominated by professional investors, who base this type of trading on research and solid beliefs.

Read: Short sellers are not bad, but they are misunderstood

Brokers require short sellers to qualify for margin accounts. A broker faces credit risk to the investor if a stock that has been shorted begins to rise instead of falling. Depending on the price increase, the broker will require additional collateral from the investor. Finally, the investor may have to cover and close the short sale with a loss, if the stock rises too much.

And that kind of activity can lead to a short squeeze if multiple short sellers are caught by surprise at the same time. A short squeeze can temporarily send the stock price soaring.

Short squeezes helped feed the 2021 meme-stock craze that sent GameStop Corp stock.

and AMC Entertainment Holdings Inc.

spiked in early 2021. Several traders communicating via the Reddit WallStreetBets channel and on other social media have banded together to attempt to short the shares of troubled companies that have been sold. slander a lot. The action sent GameStop shares skyrocketing from $4.82 at the end of 2020 to a peak of $86.88 on January 27, 2021, only for the stock to drop to $10.15. la on February 19, 2021, when the seesaw action continues to happen and the meme shares another.

short nude

Let’s say you believe a company is in financial trouble or even bankrupt, but that company’s stock is still trading at a price you consider substantial. If the stocks are highly liquid, you can borrow them through your broker for a low or almost free cost to set up your short sale.

But if many other investors short the stock, there will be less stock to lend. Your broker will then charge a higher fee based on supply and demand.

For example, according to data provided by FactSet on January 23, 22.7% of GameStop’s shares available for trading were shorted — a number that could be up to two weeks out of date, according to the data provider. financial documents.

According to Brad Lamensdorf, co-manager of the AdvisorShares Ranger Equity Bear ETF
GameStop’s cost of borrowing stock on January 23 was 15.5% annually. That cost increases the risk of the short seller.

What if you want to short a stock that has an even higher short selling interest than GameStop? Lamensdorf said on January 23 that no stock for Carvana Co.
Bed Bath & Beyond Inc.
Apart from Meat Inc.

or Coinbase Global Inc.
If you want to short AMC stock, you will have to pay an annual fee of 85.17% to borrow the stock.

Beginning last week and continuing into this week, management teams at several microcap companies (with market capitalizations under $100 million) said they were investigating. naked short sale — short selling without actually borrowing the stock.

Which brings us to three more terms:

One locate short is a service that a short seller requires from a broker. Brokers find stocks to lend to short sellers.

One natural location According to Moshe Hurwitz, who recently founded Blue Zen Capital Management in Atlanta to specialize in short selling, it is necessary to execute a “proper” short sale. The broker offers you a price to borrow the stock and place the actual number of shares in your account. Then you can shorten them if you want.

One unnatural positioning According to Hurwitz, “when a broker gives you stock that they don’t have”.

When asked if an unnatural placement constitutes a scam, Hurwitz said “yes”.

How is it possible to short sell naked? According to Hurwitz, “responsible brokers” stop placing borrowed shares in clients’ accounts when the stock supply dries up. But he added that some brokers, even in the US, lend out the same stock multiple times because it’s lucrative.

“The reason they do that is when it comes time to settle, to deliver, they rely on the fact that most of those people are day traders, so there will be enough stock to deliver.”

Hurwitz warns that the current wave of complaints about short selling is not unusual at all, and that while short selling can cause a stock price drop for a moment, “short sellers are buyers who are wait”. They will eventually buy as they cover their short positions.

“But to really push the stock price down, you need long-term investors to sell,” he said.

Various actions may appear to short nudity

Lamensdorf said the illegal short sale that Verb Technology Co.
Genius Corporation

and other small-cap companies have recently complained about the possible inclusion of non-illegal activity.

An investor looking to short a stock for which the stock is not available to borrow or the cost of borrowing the stock is too high, can engage in “swaps or decentralized derivatives transactions.” vi,” to bet on stocks,” he said.

This type of trader would be “quite sophisticated,” Lamensdorf said. He added that brokers typically have a $25 million to $50 million account minimum for investors to make this type of trade. This means that the trader is likely to be “a family office or a decent sized fund, with good liquidity,” he said.

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