Christmas Comes Early But Dont Celebrate…

The TSX  went up 7% today following the lead of global markets last night. No one was happier than me to see this and my commentary about naked short selling a couple of days ago helped spark this rally in conjunction with other initiatives to improve liquidity and the balance sheets of financial firms around the world.

While I am against naked short selling and feel that the strategy can kill some otherwise sound corporations, the strategy of short selling stock that is available to be borrowed is valid and helps keep excessive pricing at bay. Think back to the tech boom of 1999 – 2000. Excessive prices took hold and many people got burned. 

The policy of not allowing any short selling has swung the pendulum too far in the other direction and we can be sure that once the policy is reversed, the short sellers will come in and drive prices of financial stocks down but hopefully not to previous lows.

That date is slated for October 2nd. Lets all hold our breath.

What do you think will happen between now and then?


5 Responses

  1. I am reminded of a “Jackass” episode in which they rent a car, take it to a demolition derby, and then return the destroyed car to the rental agency on the following day. When the agency informs the driver that he will have to pay for the damages, he responds with a kind of “What’s your problem? I paid the rental fees, so I don’t owe you anything more” attitude.

    I don’t remember anyone asking my permission to loan them my 500 shares of AIG stock so that they could short-sell them. If they had, I would have asked “Why would I want to loan you my shares? What’s in it for me?”.

    Of course, someone short-selling my 500 shares can hardly move the market, but the larger question is why ANYONE who holds a long position would willingly give their shares to someone else only to have the shares returned a few days later damaged (or even destroyed).

    In the worst case (as with AIG), the borrower uses my shares to profit from driving down the price. I get back shares that are now worth much less than they were before. This is obviously not to my benefit.

    In the “best” case, the person shorting the shares misjudges the market and has to buy them back at a higher price, presumably to my benefit because I now get back shares that are worth more. But the increase in price isn’t based on AIG’s performance, it is based on speculative return. Such returns can evaporate just as easily as they have been created, and I fail to see how this type of trading adds any stability to market pricing (particularly for fundamental investors such as myself).

    Bearish investors and speculators can achieve the same type of short-selling results by purchasing Put options or selling naked Calls. It seems to me that speculators and hedgers should be confined to the derivatives arena where their actions can not be construed as having anything to do with INVESTOR confidence (or lack of confidence) in the underlying equity price.

    In my view, only long positions should be allowed for equities; speculators can play in the derivatives sandbox. I further submit that such segregation would make it easier to discern whether prices are being influenced by INVESTORS or by SPECULATORS.

    Given the ability to achieve the same results through the use of derivatives, my question is why don’t we simply disallow ALL shorting of equities? Given the events of the past few weeks, I doubt that anyone can any longer make the case that shorting is healthy for stable and liquid markets…

  2. Short selling is not fair today with so many large firms involved. If you were a smal guy and got into a poker game with Warren Buffett and Bill Gates ( my choice for President and VP) They could raise any pot and win even if you had a royal flush. It is the size of the shorts purse that makes it unfair.
    Let put back the “uptick” rule. And make the up tick $.25. This would slow them down and give the small long ( an investor) guy a chance.

  3. Sorry I don’t blast mail. 1st time. So what I wrote got erased.
    I think that short selling is a problem because:
    As a small investor The big guys can overwhelm a good stock with money. It is like getting into a poker game with Warren Buffet and Bill Gates. Even if I had a royal flush I could not win if I could not call the raise. BTW, These are my choice for President and VP.
    I know they aren’t running, but they are and will be my choices.
    But back to the shorting, at least we should reinstate the uptick rule. And make the up tick $.25. Then the small guy would have a chance. We could still get beat so a restriction on volume is needed.
    Naked short selling should be completely banned. If you don’t have the shares you can’t sell them. Even it is is only for a nanosecond. Mandatory Jail time and large fines if the rule/law is violated.
    Brokerage houses should be required to have EXPLICIT written instructions from and investor that it is OK to loan his shares of each company owned to a “short seller”. No blanket universal permission statement would be accepted.

  4. Hi Bob,

    I agree with your comments. Re-instating the uptick rule and explaining the effect of loaning shares to short sellers and getting the permission of investors would help reduce volatility and artificially low prices.
    Dont be surprised if this comes into effect in the near future.

  5. Hi Atticus,

    You are right that derivatives can help achieve similar results although not exactly the same, as every put option has a time premium that adjusts with the volatility of an underlying stock. Someone who believes that a particular stock is overvalued may not want to pay the current premium associated with that option.

    As well, not all securities are option eligible so the ability to buy puts or write calls is not available.

    Another option to investors that dont want there securities lent out is to request a certificate for shares owned therby eliminating a brokerage firm from lending them out for shorting purposes.

    Thanks for your reply to this blog.

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