Anywho, if you’re quick on the draw you’ll understand the implications. Shorting is for when you believe* a stock is going down. If you borrow a share from a broker that’s trading for… 10 bucks and short sell it, you pocket 10 bucks then and there. You then stand to gain as much as you buy it back for after the price goes down. If, for example, you buy the share back when the price has dropped to 5, you turn in that share back to your lender and now have netted 5 bucks. The maximum gain for this example is 10 bucks, i.e. the company bankrupts and their shares are worthless. I say “believe” with an asterisk, because there’s a caveat. We’ll come back to that.
This is from an irreverent and expletive-filled post last night by someone named Trashaccount121. It’s all about the Gamestop (GME) controversy. There’s a lot of good information in the post, although I think some of it is wrong. One important example of an incorrect statement:
Only big money hedge funds and financial institutions are allowed to short,
I’m pretty sure that’s false.
A non-economist friend who’s a daily news junkie called me yesterday afternoon to see if I was following this. I wasn’t. But I got up at about 3:45 a.m. PST and watched CNBC’s Squawk Box to see what they were saying. The GME short was the main news item they discussed. Just as the irreverent blogger above said in his post, two of the three hosts, Joe Kernan and Andrew Ross Sorkin, were talking about how bad this event was, how terrible it was that people buying stocks in units of 100s rather than 1,000s were making life difficult for hedge fund traders. From what I saw, the third, Becky Quick, was more the real reporter, showing some curiosity and some humility.
The three of them interviewed Mark Cuban on the phone. Cuban seemed to delight in what was happening and he pointed out that you shouldn’t get too upset at people for taking advantage of the rules in the marketplace. If you don’t like the behavior, change the rules. (That last statement is his thought, not mine.)
Cuban made an analogy with football. Change the NFL rules and you can expect people to game (no pun intended) the system.
Becky Quick asked if the SEC should introduce some regulation and her tone, disappointingly, suggested that she favored new regulation, although it wasn’t clear what that would be. Cuban answered that we no longer see investors in the stock market, people who buy and hold long-term. We don’t? That’s all most of my friends and I do with our Vanguard Total Market Index or the equivalent and some holdings of individual stocks. One fact that came out that surprised me is that the average amount of time a stock is held now is, wait for it, 40 seconds. I’m a little skeptical. Cuban said that you could require people to hold a stock for at least a day. He admitted that that would reduce liquidity but argued that liquidity is the not the be all and end all. (Those are my words for his thought.) I doubt that requiring stocks to be held for a day would reduce liquidity much, but I still don’t see the point. No one prevents me from holding a stock for 10 years if I want to.
Read the whole post that I mentioned above to see how the shorts got hurt by various players coming in and actually trying to make Gamestop into a successful company. It reminds me of that great movie The Producers. (That’s the picture above.) The shorts actually shorted more than 100 percent of the stock, just as the producers of a Broadway play planned for it to fail so that they could oversubscribe and sell more than 100 percent of the production.
READER COMMENTS
robc
Jan 28 2021 at 10:28am
I made The Producers reference on r/WallStreetBets* last week.
Stop stealing from me!!!
*I am not a regular there, it is weird, it truly is the 4chan of investing. But when something pops up on my reddit related to it, I check it out, and so I have been following the GME stuff pretty heavily since last week. From about $35 on. And followed thru the links back to the origin in 2019.
David Henderson
Jan 28 2021 at 10:45am
LOL. Great minds, etc.
Jon Murphy
Jan 28 2021 at 11:32am
Meanwhile, the mangers watching the price go nuts ask: “where did we go right?!”
Charley Hooper
Jan 28 2021 at 11:50am
The annual turnover rate for the Vanguard Balanced Index Fund is 37.5%, which means that each asset is held for about three years (actually, 2.7 years). If assets were held for an average of 40 seconds, the annual turnover rate would be 78,840,000% Some mutual funds have turnover rates exceeding 100%. I’ve never heard of one approaching 80 million percent.
Perhaps some day traders have such high turnover, but I suspect they are a small part of the market.
Mark Cuban is simply wrong. Most of the investors I know are the type that he says don’t exist anymore.
Mark Bahner
Jan 29 2021 at 11:22pm
Watch the “60 Minutes” pieces about high-frequency trading.
60 Minutes investigates high-frequency trading
That’s why I think the average hold time probably really is 40 seconds. I think it’s the high-frequency traders that are bringing the average hold time down to only 40 seconds.
Vivian Darkbloom
Jan 28 2021 at 12:00pm
“Only big money hedge funds and financial institutions are allowed to short,”
I doubt this was intended as an absolute statement. Certainly, there is no legal restriction. However, as a practical matter, selling short requires some financial wherewithall since the amount of your potential loss is theoretically unlimited. What I think was meant by “allowed” is that traders such as the foul-mouthed one who wrote that rant don’t have the financial backing that hedge funds and instituions have that would enable them to borrow the shares from a willing broker counterparty. I interpret this as “I tried to short sell GME but couldn’t find a broker who would deal with me”. For such persons, buying a put option would be an alternative, and much less risky to boot.
“The shorts actually shorted more than 100 percent of the stock…”
That would be illegal today in the regulated stock market as it would require naked shorting.
TMC
Jan 28 2021 at 12:27pm
“That would be illegal today in the regulated stock market as it would require naked shorting.” Correct, but that’s been happening.
I did a quick in and out of GME, made 35% in about 12 hrs. Not big money though. Too crazy for me. My kid is up 15x on his money in it. He’s been in for a couple of weeks. Was up 45x at the height. Glad he sold at least some so he locked in 5x. Almost hit 6 figures.
Steve
Jan 28 2021 at 12:30pm
Nothing illegal about it. Happens all the time. Federal Reserve Board Regulation T stipulates minimum margin requirements for short positions. Brokers often require additional “house margin”. But so long as the total account value exceeds total margin requirement, no regulation stops a US retail investor from implementing a naked short.
Vivian Darkbloom
Jan 28 2021 at 12:49pm
I’m rather thinking of Rule 203(b)(1) and (2) of Regulation SHO which would almost certainly be violated if the outstanding short volume exceeds the total number of outstanding shares. There would be no reasonable expectation at the time of trade that the location requirement of that rule would be met. I should have written “abusive naked sales”.
BC
Jan 29 2021 at 3:59am
I don’t think that’s correct. Person A shorts stock by locating and borrowing from Person B, who is long. Person A sells to Person C, who is also now long. Person D borrows from Person C and sells to Person E. A and D are short, while B, C, and E are long. Between the five of them, they are net long the 1 share, which matches what they started with (B long 1 share). However, the short interest is 200%, 2 short positions on that 1 original share of stock.
That’s also why there is nothing nefarious when short interest exceeds 100%. The *net* position across all market participants is still 100% long. So, a short interest of 140% means that the market is 240% long, 140% short.
Vivian Darkbloom
Jan 29 2021 at 6:28am
The discussion was about naked shorting.
Steve
Jan 29 2021 at 9:43am
VXX and TVIX (before it was delisted) are both good examples of securities (ETNs in this case) that are often >100% shorted. I’m not a lawyer, so I can’t speak to why this doesn’t violate the regulations you mention, but logic dictates that if this did imply a violation that we wouldn’t observe this situation so regularly.
Dylan
Jan 28 2021 at 3:00pm
I actually think this is what is meant by only the big hedge funds can do this kind of shorting, due to a specific rule that I don’t have the time to look up right now.
I’ve shorted stock as an individual many times, but there have also been opportunities where I couldn’t short shares. I never had that problem when I worked at a hedge fund and we had a big prime broker. Even microcap stocks with minimal float we were able to short.
David Seltzer
Jan 28 2021 at 11:22pm
Vivian, spot on. I was a market maker for many years on the CBOE and Amex. Later I managed a hedge fund with the dual role of risk manager. Puts allow bets on underlying stock or index declines and the risk of loss is predetermined by the premium. In point of fact, when we took bullish positions, bull spreads or outright long positions in underlying issues, we limited losses (insured) with long puts in various ratios. That is the essence of a hedge position.
Andre
Jan 28 2021 at 12:05pm
“I’m pretty sure that’s false.”
Two of the three times in the past when I tried to short stock, I was told no, no shares available to short.
So, it may be that it’s technically not true, but in practice, that’s where the little guy finds himself – unable to do what the big guys do.
Once was back when there was a gaping arbitrage opportunity between PALM and 3COM. A “no lose” situation.
Andre
Jan 28 2021 at 12:05pm
First sentence should be in block quotes. Apparently I don’t know how to use the interface.
[I put quotation marks around it for you–Econlib Ed.]
Ken P
Jan 28 2021 at 2:22pm
Individuals can short, if your brokerage firm approves you based on your liquid net worth and trading experience/savvy, but it’s definitely unusual for the individual investor to be approved for something with infinite potential loss. The typical Robinhood investor probably wouldn’t even be approved to sell covered call options. I would call the statement an exaggeration rather than outright false.
The shares available thing is an interesting spin. Selling when shares aren’t available is probably mostly limited to hedge funds/institutions.
Kenneth P
Jan 28 2021 at 2:24pm
From what I’ve heard, 136% of the stock was shorted. It makes no sense to allow selling of more shares than exist to occur.
Phys
Jan 30 2021 at 4:28pm
If there’s over 100% short then there’s way more than 100% long. The net of the longs and shorts equals the current float.
Alan Goldhammer
Jan 28 2021 at 2:35pm
I had been watching this unravel over the past two weeks and double checked short positions on some of the stocks in my portfolio as there were similar weird movements but not to the same extent as with GameStop. Stop limits for the ordinary investor are very good to use in these situations to protect on both the up and down side.
I gave up on CNBC some years ago as their on camera hosts are quite poor from a number of perspectives. Becky Quick is a good journalist and Sorkin should stick with the NY Times.
Regarding fast turnover of stocks, this is for real with the advent of high speed trading and algorithms that look for minute price differentials. Michael Lewis covered all of this in his fine book, “Flash Boys.” Big players have direct short distance lines that shave milliseconds off of trading times.
It’s not only GameStop but several other stocks with high short positions that have been under attack. There were attempts to do the same thing some years ago on Yahoo Message Boards but at the time trading commissions and the lack of on line brokers made it very difficult to pull off.
One wonders whether the Efficient Market Hypothesis is now a thing of the past.
David Seltzer
Jan 28 2021 at 11:32pm
“One wonders whether the Efficient Market Hypothesis is now a thing of the past.” Fair question Alan. Having taken Gene Fama’s classes at Chicago, and still a strong believer, I would need more empirical evidence to reject the EMH. The same question came up in 2000 with the Dot Com debacle. I suspect, given the virtual instantaneous transmission of information with social media and myriad news outlets, I think the EMH is reinforced. Of course, I could be wrong
Alan Goldhammer
Jan 28 2021 at 5:31pm
Derek Thompson has a great piece in The Atlantic on this whole fiasco.
robc
Jan 29 2021 at 12:10pm
Derek Thompson got a major detail wrong.
“Roaring Kitty” wasn’t part of the “plan”. First, I don’t know why he is using his youtube name instead of his reddit name, which is DeepF***ingValue (no actual stars, but I think econlib might filter me for accurately quoting his user name).
Secondly, DFV made his move in 2019, buying 53k worth of calls. He is (as of closing yesterday) holding 500 Apr 2021 $12 calls that he bought for 20 cents. He also has 80000 shares and $14 million in cash he has cashed out. From his youtube videos, his goal was a 4 or 5 bagger. He thought he could turn 50k into 200 or 250k.
Other than updates on his position daily he has basically been quiet.
Jonathan Seder
Jan 28 2021 at 5:57pm
“buy and hold long-term… That’s all most of my friends and I do with our Vanguard Total Market Index”
Remember – the purpose of the capital markets is to facilitate price discovery for equities, and to direct capital to the most productive uses. Passive investors are outsourcing that job to traders – individuals and pros – who gather information and try to identify pricing errors. (I think there’s an argument to be made that people with business expertise have some moral obligation [on top of the financial incentives] to play The Game rather than being passive investors.)
There is no technical problem with short interest exceeding float, and indeed no practical way to guard against that occurring (were it to be deemed desirable): when you short a stock, you borrow shares and sell them. Those shares can be borrowed again from the new owner – there’s no label on them to indicate that they’ve already been borrowed and sold short.
And yes, anyone with the financial wherewithal and expertise can short sell. The risk for any but the deepest pockets, however, is that if they can’t meet a margin call their position may be closed out at precisely the worst possible time.
David Seltzer
Jan 28 2021 at 11:34pm
Jonathan, nicely explained.
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