As an aside. If I short sold 1000 shares of McDonalds, am I obliged to replace them in one transaction?
FTR “short interest” means how much stock has already been shorted. What you mean here is that there is no stock in the “short pool” and gets a “hard-to-borrow” status.
No.
To the OP:
Morality aside, short selling is vital for 2 reasons:
- Liquidity
Market makers, block traders, and arbs, all depend on the ability to short to provide liquidity. Short offerings increase the supply available to buyers and reduces the risk of paying higher because of short term liquidity dips. Also, allowing short selling provides hedging liquidty for long futures positions for which there must be a corresponding short position which: Supports long equity positions!
- Price Discovery
The market needs a mechanism to auction prices down other than the reversal of long positions. Smart traders who believe a stock is overvalued and short it may be giving important information about the health of the company.
BTW many here are confusing shorting futures, or buying put options, with shorting stock.
IzzyR was right in that my question was in response to kabbes (John Mace also). If the broker sells the shares to complete the short sale, he is selling the shares you are trying to avoid selling, the market will be affected the same way. Unless… the broker will accept your short sale without selling any of the actual shares. He can, I suppose, just give you the cash equivalent of the shares, and the IOU without selling anything at all.
On John Mace’s point, he was concerned about avoiding short term risk, so would short stock he already owns. Seems to me that just regular old selling the shares would accomplish the same thing without all of the restrictions and complexity of a short sale. Or was I misinterpreting his post?
Well a broker could do the same for a long position as well. In either case the broker would essentially be taking the equivalent of a position of his own in the stock opposing yours, based on your order. This is typically not the role of the broker - if he wants to invest in a stock he can do it on his own.
Huh? Of course the broker has to sell the shares.
I’m just trying to figure out how giving an order to short sell a stock could result in a different market condition than you just selling stock from your own account. From my investor perspective, I don’t really care if the broker actually owns or sells any of the stock I’m trying to short, as long as I get the cash from him and owe him the stock as per the normal shorting agreement.
He could (let the imagination run wild here) decide he wants to go longer with that stock today and buys 100 more shares then sells them immediately for my short order. His overall portfolio doesn’t change, he gives me my money, and I owe him the stock through the normal policy. In reality, he wouldn’t bother to buy and sell, he’d just give me the cash and IOU.
Well first off, the scenarios you speak of are illegal. You may not care if the broker owns or buys any of the stock you’re trying to short but the SEC and clearinghouse sure as hell do. The broker wouldn’t be able to take a position for his own account nor would he likely be able to take a position for the firm.
The difference between finding an existing long position to borrow vs. the broker buying a position to let a customer short, is that in the former, there is no buying pressure coming in to the market. That pressure occurred when the original buyer purchased the shares. In the latter example, a broker must buy first in order to sell for you.
A short sale is different than a long liquidation for several reasons. The former necessitates a covering purchase sometime in the future and thus admits a source of potential buying power. This will show up in short interest which will further affect investor decisions. Your short sale also effects the ability of other potential shorters by removing stock from the short pool.
I think I need to think about this. My expertise is in liabilities, not assets. My posts so far has come from knowledge gained from theory only, learned about three years ago. I may have mixed up some small but crucial area.
In particular, I’m reminded by KidCharlemagne’s post that the really crucial part of the futures trade is liquidity. I’m wondering whether I’m making the common mistake of confusing marketability for liquidity. Futures are incredibly liquid, as I understand, making it much easier to sell short than to sell the actual stock, which is a major reason for their use in portfolio-rebalancing. I was always under the impression that it also has the further effect of not depressing price, but I’m willing to concede that this doesn’t, on the surface, appear to make much sense.
pan
Selling futures will increase the spread between the future and the actual index, potentially creating an arbitrage opportunity where one would buy the futures and sell the basket of stocks that the index represents. Selling futures will, ceteris paribus decrease the price of the cash market.
From your language it appears that you are conflating futures with short sales. (KidCharlemagne remarked on this in post #24). A future would be an option to buy or sell a stock, at or before the expiration date, at a predetermined price. (US options can be exercised at any point before the expiration date. It is my understanding that British options can only be exercised on the expiration date itself). A short is an actual marketplace sale of (borrowed) stock. A short sale has the same impact on price as any other sale. A future sale does not, as it does not involve an actual sale of stock.
(As an aside, on odd way in which short sales affect the market is that they increase the number of shares available to a number greater than the actual number of shares that exist, similar to the way banks can increase the money supply. As an example, suppose a company had only one share of stock, owned by X. Now suppose Y shorts the stock - his broker borrows X’s share and sells it to Z. Now the company has two people each owning one share of it’s stock, even though only one share actually exists)
Bingo. You finally got through. I was treating futures and selling short as being one and the same. In fact the actual selling short of a stock had not even entered my head at any point up to now – I was talking about futures the entire time. It all makes much more sense now.
pan
A future does not contain an option to buy or sell (that would be an option), it is an agreement to deliver or receive a certain product, at a certain place, on a certain date at a price agreed upon buy the buyer and seller. I’m not sure what you mean by “future sale,” but sales of a future do effect price.
Well your OP talked about Osama shorting stocks before 9/11. That was stock he shorted, not futures. There are no futures on individual companies, just indexes, currencies, and commodities–macro stuff. Generally when someone makes an argument about the ethics of short-selling, they are speaking of stock, not futures. I think you were actually talking about stocks, but correct me if I’m wrong.
You are correct. My language was careless - sorry. (I used “futures” to refer to options, which are, as you note, available for stocks).
BTW, kabbes is not the author of this OP - that would be BwanaBob.
Selling short is only wrong if you do so and then deliberately engage in activity that causes that stock to fall. It’s been done. Seem to remember a politician doing it awhile back.
There is an interesting corollary to this, actually. There has been a lot of controversy in the UK recently about betting exchanges. This allows the punter to act as bookmaker – you can offer odds on a horse to win rather than taking somebody else’s odds. But this, in effect, is the same as betting on the horse to lose.
What’s so bad about that? Well a number of high-profile horse-owners and jockeys were caught offering odds. So they were backing their horse to lose. A couple of extremely dodgy-looking falls and pull-ups later and we have a big problem…
pan
There’s also the controversial naked shorts:
http://askmerrill.ml.com/markets_news_story/0,2263,{193A704E-EA2E-47AF-B78F-A10C3239F370},00.html