Naked Short Selling / by kevin murray

The average investor believes that there is only one bet that you can make in regards to the stock market which is to buy a stock and hope (or pray) that your particular equity goes up in price over time, and thereby allowing you to reap profitable returns.  That is probably the most common type of trade but it certainly isn't the only way to play the market.  For instance, there are other people, who are naturally pessimistic, or perhaps don't believe in the particular hype of a certain stock, or are contrarians for one reason or another, that also want to play the stock market, but do not want to buy a stock that they hope will go up, but instead would like to invest in some manner where they can bet that a stock will go down in monetary value.  Not too surprisingly, since Wall Street desires to accommodate all comers, that type of investment is known as a "short sell", which basically means that you are borrowing the shares at today's price, which gives you thereby the option of purchasing the shares later, at what you hope to be at a lower price, and subsequently garnering a profit.  In summation, when you go long, you for example  purchase 100 shares at $12/share, and if you later sell the same stock and all your shares for $15 share you have made a profit of $30 ($150 sell price - $120 buy price), which doesn't take in account any commissions that you may have paid.  When you short a stock at let's say $12 share for 100 shares, that means you have borrowed the shares, when you later actually buy the 100 shares at $10 share and thereby close out your position you have made a profit of $20 ($120 sell price - $100 buy price).  Again, the concept of selling short a stock is your belief that the stock will fall, so you borrow the shares from your brokerage company at the higher price, and then return the same shares at the lower price, pocketing the difference.


All of the above is perfectly legal and fairly routine, as the fact that an investor can bet on either the "long" or the "short" side of a particular security allows investors to place a bet per their volition. The key thing to remember is that when you purchase shares of a stock, those shares are issued to your brokerage and assigned to your account, whereas when you short shares, you are borrowing shares from your brokerage company that you will replace at a future point at your discretion.  The difference between naked short selling and short selling is that in regards to naked short selling, the actual shares themselves are never borrowed in the first place.  While that might on the surface just sound like quibbling, the problem with naked short selling is that these phantom shares can be utilized by sophisticated traders in certain stocks, to artificially push down the price of a stock, because this oversupply of phantom shares disturbs the normal equilibrium between the actual shares of stock being bought as well as the actual shares of stock being borrowed or sold, and too many sellers at the same time will have a strong tendency to lower the price of the equity.  So that with naked short selling, because you do not have borrowed shares and are in fact in a position in which in actuality you will "fail to deliver" the actual borrowed shares of stock because you are naked short selling, this increased volume of sellers, will in essence corrupt the equity system, and typically result in the equity price being lowered, and consequently when you close out your phantom position, you will have made money at the expense of legitimate stockholders.


While naked short selling is a financial crime, it is also a crime that is hard to discover, and also hard to prove, consequently the practitioners of naked short selling ply their trade, recognizing that the lure of easy money far outweighs any ethical concerns that they may have or legal concerns that might worry those of a different ilk.