Thursday, July 17, 2008

Short Selling Rules

Interesting write up about the new short trading rule. I was not all that aware of all the short trading talk the last few days while I was traveling. I still don't know all the details but on the surface the rule makes sense. Yes it has hurt some of my positions with the blitzkrieg in covering and I heard yesterday that getting a borrow was much more difficult but logically (few people can think logically if something works against their book) you should not be able to short something until you secured the borrow. That should have been the rule for eons. Of course the SEC is targeting certain stocks which seems ridiculous.

This new rule won't stop something from going down, it just probably makes the market more rational and creates technical reasons for a bounce (combined with the fact that many of those names were way oversold). You will not have traders piling on selling something that haven't already borrowed. The reverse would be buying something making the price go up before you take delivery. That just sounds absurd. Blaming short traders and limiting short trading is ridiculous. Making logical rules that should exist in an orderly market should be supported even if it works against your book. Information about these new rules could come out with added restrictions that do not make sense and change my opinion but on the surface it looks okay.

The rule changes proposed by the SEC for selling stocks short are meant to curtail “naked” short selling, selling stock short without locating a borrow. They tighten up procedure between lender and borrower through broker dealers. For example, in the past a short seller would sell stock and then call the broker for a “locate," a stock available at the dealer to borrow. And even if he called first and the dealer had no “available locate” at the current time, the dealer probably told the seller to go ahead knowing that the locate would come at some point.

It's still not clear how to interpret the new procedure, but it looks like now “the locate” must be currently in the box. This is going to raise the cost of borrowing. In other words, the rebate rate credit to the short sellers account (the interest they earn on the cash they generate by selling the stock) will be less.


Mikey said...

At the retail level, you had to be able to borrow, or you couldn't even enter the order.

I'm thinking the impact now is that you actually borrow before you sell (rather than being able to borrow), which means that perhaps if you put in an order to short fannie at 100 (something that wouldn't be filled), then you could hog up all the borrow. I don't know, just guessing.

I also thought some of these rules were temporary (one week). As far as naked shorting, though, that should never be allowed by anyone by but the market maker.

Market Seer said...

Yeah your completely right at the retail level. The big impact is on institution platforms. So the way it worked often was say I was watching say Citigroup and all of a sudden I wanted to trade it. Well I would put in the order essentially making a naked short while my prime broker than went out and secured the shares. Now the broker has to secure the shares before the order is executed. This lessens liquidity. Hypothethically as a stock was being driven down there could be more shares short than outstanding. Also my understanding is that the rule may limit the amount of shares shortable because the shares can't be pooled. So JP Morgan as Prime Broker cant pool their shares with Citigroup as available shares to short.

The rule is temporary but just like the all the various windows the and programs the FED has now if it is working I would bet my bottom dollar it will be extended. Working is defined in the government eyes is causing things to go up even if it is overvalued. My guess is the correlation of this very violent rally with this SEC move will be to much for the government to pull it back.

Mikey said...

In homage to Mr. Cox, the next time I short a stock, I will strip down buck naked while placing the order.

Market Seer said... pictures please