“I thought every short required a long to make the transaction complete.”
True. When you buy a share of stock, atleast on the NYSE or AMEX, you are buying from a/the market maker, who shorted (sold) it to you. You cannot conduct a transaction directly with a “short”, eg; a retail someone who is bearish on a stock who goes out and through the action of entering a short-sell order on said stock becomes short the stock. That’s the long-short symmetry. But the difference is that the market maker maintains a hedged position on VAST majority of the shares he owns and will not take much market risk. So, after he sells you your share on which you are now long, he looks at his holdings and decides whether his net long or short position is within his risk tolerance. That is...if he wants to stay in business. He will take very moderate directional risk but prefers to make money on the bid/ask spread thousands or hundreds of thousands or millions of times a day. If your order to buy makes him shorter than he cares to be, he will buy calls and increase his long position, and the same is true in reverse.
Good post.
One way in which “naked short selling” occurs is that a large hedge fund manager who is short the common stock desperately wants the price to go down. So he will buy for example 1000 put contracts, which is the equivalent of 100,000 shares. The market maker sells him the puts, but does not want the risk associated with being short puts, so at the same time the Market Maker forces the hedge fund manager to buy 100,000 “shares” from his “inventory” — which in fact is nothing more than a ledger entry. The market maker does not have to have stock to sell the stock they are obliged to make a market and they are entitled to sell “naked” in the course of their duty in making the market.
So the hedge fund manager now has 100,000 “shares” which he can sell into the market to either undermine rallies, or ‘pile on’ on down days, or to churn, or to cover without disrupting the intraday market trading.
This is called “renting the market maker exemption” and is used quite a lot once a stock reaches its threshold in terms of the amount of legitimate shares available for borrow.
This is how shorts can get the upper hand especially over mid-cap stocks with modest sized floats. The supply of shares is artificially increased, and the companies targetted for short sellers are the types of companies that don’t get widespread coverage, have high growth, or large investment backing by long funds and institutions. There just aren’t enough interested longs to drive the shorts out.. in fact in a lot of cases the hedge fund has more cash than the entire market cap of the companies they target.