Daniel X. Bustamante, Co-Founder and Lead Coach
So recently I read this article here from the Robinhood CEO discussing short-selling.
His idea is that maybe short-selling should be limited or rather not being allowed to short over and over. He made an argument that they could only be shorted once.
First, let me start by saying I am always open to market debates as long as they provide some efficiency. Plus, as long as they don’t happen during market trading hours so I can focus on trading actual markets.
That being said, I disagree with him and I want to discuss short-selling in this blog post and dive into why this is even a topic.
This all started with Gamestop in February and again last week. Shares of Gamestop we’re ‘naked shorted’ meaning that major hedge funds illegally short-sold shares. Now this get’s tricky. One, what is naked shorting? It’s not what you think. Second, what is short selling anyway?
I don’t want to make a huge section on short-selling so you can read the cliff notes here.
Basically, it’s you borrowing shares of a stock that someone else owns and selling it to the market. What Investopedia or other basic finance sites are not going to tell you is this: The brokers (Schwab, E-Trade, TD, Goldman etc) all make money brokering this. Its a MASSIVE revenue stream for these brokers to lend out shares. You as the person who say owns Apple shares may get a call and say: “Hey you own these shares how would you like to make mone lending them out at say 5%” Schwab will then lend them to say, me, for a higher rate, keeping the spread.
So short selling has a lot of dynamics related to how markets function but also how the brokers function. It’s not as simple as most take it at face value.
Now the question Vladimir poses “Should stocks only be allowed to short once” is valid but then again maybe he forgot that he will mess with the pockets of the brokers.
Situations like Gamestop where the stock keeps trading to where it’s at is just pure market manipulation. By the hedge funds and retail traders alike. Let’s start with that. So taking this idea that he wants to do because one stock has done this, is, in my opinion, premature and short-sighted.
What is happening in Gamestop is a massive one-off situation.
Now of course you can make the argument that this could open the doors to other stocks having the same issue. Yes and no. Gamestop is and was a special situation. Naked Short Selling (read about it) caused the move to become exacerbated.
Naked shorting is bad. It is the root of a lot of things in markets where it causes problems. Us, as retail traders, will never get the chance to do it, but, if you’re a big hedge fund you get preferential treatment. I don’t agree with naked shorting, at all. It drives the pressure of equities lower than it fundamentally should be, in fact, it is cheating by all definitions.
Now I do agree with short-selling. Let me just say that. Short-selling allows for market participants to say “the emperor has no clothes” and express their opinions on fraud or other things they believe the Company is at fault with.
Again, should Gamestop be where it’s at? After all, it’s caused a lot of drama in the markets. The idea that ‘it can be whatever price it wants’ is true. However, we all know that it is not worth that.
The markets are extremely dynamic and interesting once you dig into them more. For me, Gamestop presents an opportunity, not to short the shares but to maybe sell premium on, which, we’ll save for another post.
So while the markets may have a problem there are always solutions or exits if you will. Gamestop created a fiasco but out of that it created an opportunity, you just have to know what perspective to look at it from.
Thanks for reading.
Daniel X. Bustamante