Ah, thanks! Relatedly, do you understand what Eliezer is talking about with “naked shorts” here? I looked up the investopedia article on naked shorts, but, I didn’t understand what they actually were. Supposedly it’s shorting a stock without borrowing it first. But how does that work?
Regular shorting:
Borrow a stock. (Get a stock, promise to give it back later, plus some fee/interest.)
Sell it for the money.
(Time passes.)
Buy back the stock, hopefully at a lower price.
Return it to lender.
I’m not sure which steps are omitted in a naked short. If you don’t borrow a short, I guess you don’t have to give it back (so strike #1 and #5). That leaves 2-4. But, how can you sell it if you don’t have it? Naked shorts are illegal, but they only became illegal around 2008. I’d think something so basic as selling something you don’t have would have been simple fraud.
So this makes me think a “naked short” might instead mean:
Promise to give someone the stock later (get money),
Your first description is a “naked short”. A “covered short” or “hedged short” includes step 1.5 - buy a call option or otherwise arrange a way to get the share back, even if open-market shares are more expensive than you can afford. note that WRITING a call option has much the same impact as selling a share short—you run the risk of the option being excercised (buyer chooses when!) and not easily delivering the share. And often are hedged the same way—write calls, and buy different calls (with different expiry or strike price, so they’re cheaper than the ones you write).
Your second description is a pure futures contract, which AFAIK happens for commodities, and not for stocks. This kind of trading drove the price of crude oil negative last year (also with big headlines that the financial system was exploding) when futures buyers realized they couldn’t actually take delivery of the oil.
Ah, thanks! Relatedly, do you understand what Eliezer is talking about with “naked shorts” here? I looked up the investopedia article on naked shorts, but, I didn’t understand what they actually were. Supposedly it’s shorting a stock without borrowing it first. But how does that work?
Regular shorting:
Borrow a stock. (Get a stock, promise to give it back later, plus some fee/interest.)
Sell it for the money.
(Time passes.)
Buy back the stock, hopefully at a lower price.
Return it to lender.
I’m not sure which steps are omitted in a naked short. If you don’t borrow a short, I guess you don’t have to give it back (so strike #1 and #5). That leaves 2-4. But, how can you sell it if you don’t have it? Naked shorts are illegal, but they only became illegal around 2008. I’d think something so basic as selling something you don’t have would have been simple fraud.
So this makes me think a “naked short” might instead mean:
Promise to give someone the stock later (get money),
(Time passes.)
Buy the stock (hopefully at a low price).
Give it to the promisee.
Your first description is a “naked short”. A “covered short” or “hedged short” includes step 1.5 - buy a call option or otherwise arrange a way to get the share back, even if open-market shares are more expensive than you can afford. note that WRITING a call option has much the same impact as selling a share short—you run the risk of the option being excercised (buyer chooses when!) and not easily delivering the share. And often are hedged the same way—write calls, and buy different calls (with different expiry or strike price, so they’re cheaper than the ones you write).
Your second description is a pure futures contract, which AFAIK happens for commodities, and not for stocks. This kind of trading drove the price of crude oil negative last year (also with big headlines that the financial system was exploding) when futures buyers realized they couldn’t actually take delivery of the oil.