Naked Shorting is Illegal: So How the Hell was GameStop 140% Short?

 

Allow me to illustrate:

I own 1000 shares of Consolidated SH*T in a margin account.   Thus 1000 owned zero short.

I lend my 1000 shares to the short seller.  He sells to me 1000 shares and receives cash.

I own 2000 shares of  Cons. SH*T now.  The short seller is 1000 shares short.

Repeat four more times.

I now own 6000 shares of Cons SH*T and have lent out the same 1000 shares a total of five times.  The short seller is short five thousand shares and has cash on hand.  Thus for 1000 real shares we have produced a short of 5000 shares.  None are actually naked in this scenario.  Naked only means that a convenient source is unavailable to put this daisy chain together.

Of course, if i decide i want delivery of the total 6000 shares, the short seller has a real problem in my limited scenario as those other shares still do not exist.

Now you understand why short selling must be tightly controlled and limited to deep markets with options available.

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Naked Shorting is Illegal: So How the Hell was GameStop 140% Short?

Mish

Jan 30, 2021

GameStop was 140% short. That is illegal. So how did it happen?

Naked Shorting Explained

Naked shorting is the illegal practice of short selling shares that have not been affirmatively determined to exist. Ordinarily, traders must borrow a stock, or determine that it can be borrowed, before they sell it short. So naked shorting refers to short pressure on a stock that may be larger than the tradable shares in the market. Despite being made illegal after the 2008–09 financial crisis, naked shorting continues to happen because of loopholes in rules and discrepancies between paper and electronic trading systems.

The above is from Investopedia What is Naked Shorting?

What's Going On?

It is illegal to be naked short in excess of float except for market makers who have to take the other side of a trade.

It was not the market makers who were naked short. It could be in theory, but not in this case, at least not yet.

Hedge funds wanted to short and they have to borrow stocks to do so.

The hedge funds get those shares from somewhere. Where? The brokerages and the market makers such as Goldman Sachs.

It should be the responsibility of the brokerages and market makes to not let hedge funds get 140% short. But they did, and I believe on purpose.

Since the public cannot be 140% long, except via options, who was effectively long the other 40% of the shares?

The brokerages and the market makers. To get even more shares for themselves, they restricted trading.

So while these Redditt traders did well, the market makers also gained immensely on the meteoric rise. The more the merrier. They screwed the hedge funds big time and purposely so.

A side artifact of points #1 and #2 is when the shorts are all squeezed out the market makers are the only ones who are short.

When that happens, the bids plunge and the market makers cover lower.