Germany To Ban Short Selling At Midnight

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Germany To Ban Short Selling At Midnight

Over on Zero Hedge there is an article about Germany banning short selling.

http://www.zerohedge.com/

Tyler Durden seems to think that this will cause significant stress to the markets.

....the German Finance Minister will institute a short-selling ban at midnight. If true, this is huge....

I was hoping that some of our knowledgable market people here could opine on the implications for US.

Ken

 

 

 

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Re: Germany To Ban Short Selling At Midnight

 LInk to the article

 

http://www.zerohedge.com/article/germany-ban-short-selling-midnight

 

 

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Re: Germany To Ban Short Selling At Midnight

unintended consequences will happen.  We'll know after it happens.

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Re: Germany To Ban Short Selling At Midnight

In order to understand why this is dangerous and disruptive to the markets, to ban short-selling, it is necessary to understand that there are two kinds of short selling:  naked and covered.

In a covered short sale, an owner of a stock purchases the right, but not the obligation, to sell that stock at a predetermined price (called the strike price).  The cost of the option is called the premium.  This option provides a mechanism for the stock owner to lock-in a sale price.  Why not just sell it?  The stock owner may anticipate further appreciation, but wants to guarantee a lock-in price in case he is wrong.  Or, the owner could want to stay in the stock for more time in order to qualify for dividends.  It does not really matter why - the point is that covered short selling provides insurance - it guarantees a sale price, and thus provides stability to the marketplace.  Without them, there would be more selling, since stock owners could no longer guarantee a predetermined sale price.  The fact they are willing to pay a premium in order to guarantee the sale price, proves that the risk of not having the options available is real and quantifiable.  Remove the ability to buy sell options, and stock owners will experience increased risk.  This doesn't mean they will all sell, but it certainly means some will.  The net net of it is that this removes a stability function of the marketplace.

In a naked short sale, someone purchases the right to sell a stock that they do not own.  The market made by actual stock owners who do own the stocks they purchase options in, is also available to anyone who wishes to participate.  Naked short sellers are simply speculating on the options market itself, which was intended to be an insurance-like mechanism for actual stock holders, even though they do not own any of the corresponding stocks they buy options in.  Naked short sellers provide liquidity to the marketplace, but they also could (and some say have) distort marketplaces by taking huge positions.

Regardless of what one's opinion is on naked short selling, there is no denying that covered short selling provides stability to the marketplace and is a legitimate market tool.  Whether Germany is banning naked short selling or all short selling I do not know.  Even a ban on naked short selling could be destabilizing as it will remove a lot of liquidity from the marketplace.  High liquidity reduced ask/bid spreads, which is to the benefit of all participants.  Low liquidity forces market makers to take on large ask/bid spreads, increasing premiums for all short sellers- be they naked or covered.

I'm sure there is much more to all this that others on this site are much more versed on than myself, burt that's the best I can muster.

FB

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Re: Germany To Ban Short Selling At Midnight

Thanks FB for the explanation, there was a similar one in a post under the original ZH article, and they are very helpful. They are getting desperate over there and this is looking like one of those government boondoggles that will completely backfire on them... which is just fine by me.

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Re: Germany To Ban Short Selling At Midnight

As I understand it from the media (Spiegel-online), it is about "naked short selling".

Article in German here: http://www.spiegel.de/wirtschaft/soziales/0,1518,695516,00.html

Greetings from Germany,

Regina

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Re: Germany To Ban Short Selling At Midnight
Farmer Brown wrote:

In order to understand why this is dangerous and disruptive to the markets, to ban short-selling, it is necessary to understand that there are two kinds of short selling:  naked and covered.

In a covered short sale, an owner of a stock purchases the right, but not the obligation, to sell that stock at a predetermined price (called the strike price).  The cost of the option is called the premium.  This option provides a mechanism for the stock owner to lock-in a sale price.  Why not just sell it?  The stock owner may anticipate further appreciation, but wants to guarantee a lock-in price in case he is wrong.  Or, the owner could want to stay in the stock for more time in order to qualify for dividends.  It does not really matter why - the point is that covered short selling provides insurance - it guarantees a sale price, and thus provides stability to the marketplace.  Without them, there would be more selling, since stock owners could no longer guarantee a predetermined sale price.  The fact they are willing to pay a premium in order to guarantee the sale price, proves that the risk of not having the options available is real and quantifiable.  Remove the ability to buy sell options, and stock owners will experience increased risk.  This doesn't mean they will all sell, but it certainly means some will.  The net net of it is that this removes a stability function of the marketplace.

In a naked short sale, someone purchases the right to sell a stock that they do not own.  The market made by actual stock owners who do own the stocks they purchase options in, is also available to anyone who wishes to participate.  Naked short sellers are simply speculating on the options market itself, which was intended to be an insurance-like mechanism for actual stock holders, even though they do not own any of the corresponding stocks they buy options in.  Naked short sellers provide liquidity to the marketplace, but they also could (and some say have) distort marketplaces by taking huge positions.

Regardless of what one's opinion is on naked short selling, there is no denying that covered short selling provides stability to the marketplace and is a legitimate market tool.  Whether Germany is banning naked short selling or all short selling I do not know.  Even a ban on naked short selling could be destabilizing as it will remove a lot of liquidity from the marketplace.  High liquidity reduced ask/bid spreads, which is to the benefit of all participants.  Low liquidity forces market makers to take on large ask/bid spreads, increasing premiums for all short sellers- be they naked or covered.

I'm sure there is much more to all this that others on this site are much more versed on than myself, burt that's the best I can muster.

FB

 

FB,

I don't think we are talking about options here are we.

An option gives you the right to buy or sell

A short sale is an outright sale of stock - Covered Short if you have borrowed it and Uncovered short  if you do not actually have the stock in your possession.

Correct me if this is wrong.

Ken

 

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Re: Germany To Ban Short Selling At Midnight

Also banning of cds on euro gov bonds

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Re: Germany To Ban Short Selling At Midnight
Ken C wrote:
Farmer Brown wrote:

In order to understand why this is dangerous and disruptive to the markets, to ban short-selling, it is necessary to understand that there are two kinds of short selling:  naked and covered.

In a covered short sale, an owner of a stock purchases the right, but not the obligation, to sell that stock at a predetermined price (called the strike price).  The cost of the option is called the premium.  This option provides a mechanism for the stock owner to lock-in a sale price.  Why not just sell it?  The stock owner may anticipate further appreciation, but wants to guarantee a lock-in price in case he is wrong.  Or, the owner could want to stay in the stock for more time in order to qualify for dividends.  It does not really matter why - the point is that covered short selling provides insurance - it guarantees a sale price, and thus provides stability to the marketplace.  Without them, there would be more selling, since stock owners could no longer guarantee a predetermined sale price.  The fact they are willing to pay a premium in order to guarantee the sale price, proves that the risk of not having the options available is real and quantifiable.  Remove the ability to buy sell options, and stock owners will experience increased risk.  This doesn't mean they will all sell, but it certainly means some will.  The net net of it is that this removes a stability function of the marketplace.

In a naked short sale, someone purchases the right to sell a stock that they do not own.  The market made by actual stock owners who do own the stocks they purchase options in, is also available to anyone who wishes to participate.  Naked short sellers are simply speculating on the options market itself, which was intended to be an insurance-like mechanism for actual stock holders, even though they do not own any of the corresponding stocks they buy options in.  Naked short sellers provide liquidity to the marketplace, but they also could (and some say have) distort marketplaces by taking huge positions.

Regardless of what one's opinion is on naked short selling, there is no denying that covered short selling provides stability to the marketplace and is a legitimate market tool.  Whether Germany is banning naked short selling or all short selling I do not know.  Even a ban on naked short selling could be destabilizing as it will remove a lot of liquidity from the marketplace.  High liquidity reduced ask/bid spreads, which is to the benefit of all participants.  Low liquidity forces market makers to take on large ask/bid spreads, increasing premiums for all short sellers- be they naked or covered.

I'm sure there is much more to all this that others on this site are much more versed on than myself, burt that's the best I can muster.

FB

 

FB,

I don't think we are talking about options here are we.

An option gives you the right to buy or sell

A short sale is an outright sale of stock - Covered Short if you have borrowed it and Uncovered short  if you do not actually have the stock in your possession.

Correct me if this is wrong.

Ken

If they're banning short sales of stocks (covered) the effect is the same.  People sell stocks short to secure a gain.  If they already own the stocks, it's a covered short sale.  If they do not, it is naked.  Covered short sales provide the same insurance put options do.  Naked short sales, assuming the broker really does lend real shares to the transaction (as opposed to this: http://www.rollingstone.com/politics/news/%3bkw=%5B3351,11470%5D which is just outirght fraud) may be completely void of any benefit at all to the marketplace for all I know.  I am not sure on that one.  Covered short selling however, is legit and reduces risk to market participants who use it, be it option based or share based.

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Euro Breaches $1.22

Look at that action -- Euro breaches $1.22 and loses something like 1.5% in short order.  I'm assuming this is related to Germany's short selling ban.  What does this mean?  What is going on?  (P.S.  This is an inverse chart).

euro

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Re: Germany To Ban Short Selling At Midnight

After the US banned all shorting in financial stocks (and many stocks they put into the financial sector on a whim), they tanked. 

I think its important for everyone to realize why this might be, and why this might hurt the Euro or German equities.  Traders/hedge funds/prop desks are in fact the ones that provide liquidity in severely down markets.  Even short term program trading tends to buy more than sell in severely down markets.  However, in order to take this risk, they like to hedge with at least moderately correlated instruments - whatever they may be.

What happens when you take away this ability to hedge (which in this case is going short a stock perhaps, or buying CDS...or even shorting a stock to hedge a long option position) is that the underlying long gets discarded as too risky. 

To put it another way, the masses dont tend to buy pukeouts...they panic and sell.  Its the hedge fund/professional trader who is usually taking the other side (I know there are lots of exceptions...but in dollar terms these participants are the overwhelming majority of the bid side).  But, without their usual risk reduction tools they wont take as much risk, and downside moves in stocks have tended to be more extreme.

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Re: Germany To Ban Short Selling At Midnight
Farmer Brown wrote:

In order to understand why this is dangerous and disruptive to the markets, to ban short-selling, it is necessary to understand that there are two kinds of short selling:  naked and covered.

In a covered short sale, an owner of a stock purchases the right, but not the obligation, to sell that stock at a predetermined price (called the strike price).  The cost of the option is called the premium.  This option provides a mechanism for the stock owner to lock-in a sale price.  Why not just sell it?  The stock owner may anticipate further appreciation, but wants to guarantee a lock-in price in case he is wrong.  Or, the owner could want to stay in the stock for more time in order to qualify for dividends.  It does not really matter why - the point is that covered short selling provides insurance - it guarantees a sale price, and thus provides stability to the marketplace. 

Sort of - what you are describing here is nothing more than the purchase of Put options.  Most traders do this to insure a stock position against a price drop.  You have several options (no pun intended) with the purchase and sale of Puts.  As the price of the underlying equity drops, the price of the associated Puts will rise.  Once the price drop has run its course, you can sell the Puts at a profit and reduce your position price in your stock position because you have the cash from the sale of the Put contracts.

I think you are mishmashing the selling of covered Call options here.  You can sell covered calls all day long as long as you own the underlying equity in sufficient inventory to cover the number of Call option contracts you are selling.

You can also sell Naked Puts and Calls, but just about every brokerage requires the seller have enough cash inventory to either purchase the stock to deliver to the buyer of a naked call option or to purchase the stock from the buyer of a naked put option.

In short (again, no pun intended) I would revise your opening sentence to read:

......it is necessary to understand that there are two kinds of short selling:  short selling (ownership of sufficent inventory of the underlying stock being sold short) and naked short selling (fabrication of the inventory of the underlying stock).

FWIW, Cat and I don't sell short.  I have an issue with a technique that actually puts downward price pressure on an equity.  Short selling is legal, but I won't do it.

Quote:

In a naked short sale, someone purchases the right to sell a stock that they do not own.  The market made by actual stock owners who do own the stocks they purchase options in, is also available to anyone who wishes to participate.  Naked short sellers are simply speculating on the options market itself, which was intended to be an insurance-like mechanism for actual stock holders, even though they do not own any of the corresponding stocks they buy options in.  Naked short sellers provide liquidity to the marketplace, but they also could (and some say have) distort marketplaces by taking huge positions.

Again, if I understand your post, I think you are confusing a legitimate market technique (options sale/purchase) with a bullshit technique (Naked short selling of a stock). 

What you have sort of described here is buying Put option contracts.  Ownership of a stock is not a prerequisite to buying and selling Put (or Call) options.  Options don't necessarily have anything to do with naked short selling (unless you are Naked short selling options?????  I can't even contrive a scenario where this could be done with options.)

Naked short selling is a case of short selling without first arranging what is called a borrow. In other words, the seller doesn't own any shares of  the underlying equity - and what's worse, the stock inventory that was sold short doesn't and never did exist.  When shares are not borrowed (or purchased) within the 3 day clearing time period and the short-seller does not provide the shares to the buyer, the trade is considered to have "failed to deliver." The trade remains open or the buyer may be credited the shares (creating a false inventory) until either the short-seller closes out the position or borrows the shares.  These get lost once the seller borrows/buys sufficient shares since the trade essentially becomes a legitimate short sell.

Naked short selling is a fabrication of the market. Someone is selling something they don't own AND "they" are creating an inventory they don't account for.  Back before the crackdown on Naked short selling, there were instances of naked short trades being made involving stock inventories that were more than a thousand times higher than the shares outstanding inventory.  Computerized trading allowed this type of baloney to go on unchecked within the daily noise of market movement. 

From Investopedia:  http://www.investopedia.com/terms/n/nakedshorting.asp

Naked Shorting

What Does Naked Shorting Mean?

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. But due to various loopholes in the rules and discrepancies between paper and electronic trading systems, naked shorting continues to happen.

While no exact system of measurement exists, most point to the level of trades that fail to deliver from the seller to the buyer within the mandatory three-day stock settlement period as evidence of naked shorting. Naked shorts may represent a major portion of these failed trades.

Investopedia explains Naked Shorting

Naked shorting is illegal because it allows manipulators a chance to force stock prices down without regard for normal stock supply/demand patterns.

In 2007, the Securities and Exchange Commission (SEC) amended Regulation SHO to further limit possibilities for naked shorting by removing loopholes that existed for some broker/dealers. Regulation SHO requires lists to be published that track stocks with unusually high trends in "fail to deliver" shares. Some analysts point to the fact that naked shorting, albeit inadvertently, may help markets stay in balance by allowing the negative sentiment to be reflected in certain stocks' prices.

 

I hope this helped - I read it over a bunch of times and I have confused myself.

Naked short selling - BAD

Short selling - NOT BAD

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Re: Germany To Ban Short Selling At Midnight

Dogs in a Pile:  Good post, however I have to disagree with you regarding short selling putting downward pressure on a stock.  While the process of any sell will put downward pressure on a stock, this short will be covered at some point putting upward pressure on the stock.  The added component is liquidity.

As I alluded to above, when this liquidity from the ability is to short is gone (when the US banned shorts in financials in 08), stocks can suffer more dramatic swings as that liquidity disappears.  Remember, most professional traders and hedge funds short before a stock moves down substantially, and provide liquidity by covering their shorts if the stocks are in freefall.  Net net the buy vs selling pressure created, over time, is zero.

My entire post is only a discussion on shorts with stock in inventory to cover it...not naked.  Naked is a scam....a fraud.

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Re: Germany To Ban Short Selling At Midnight

Hang on, let's be sure to get our terms right...A lot rests on knowing exactly what is being limited or banned in order to determine the potential effects.

For the record, short sellers not only provide a lot of additional liquidity to the marketplace, they usually set the bottoms of big downdrafts in what's known as a "short covering rally."  I have personally participated in more than a few of those.

A put option is not the same thing as a 'short sale' and these can be either naked or covered.  However, when discussing short selling, options are not typically part of the discussion.

A stock short sale means borrowing shares to sell (with the intention of buying them back at a lower price and then returning them to the original owner while pocketing the difference).

A 'naked short sale' means selling shares that you have not borrowed.  In fact, they do not exist.  This happens all the time in the US markets, I am not as certain about other markets.  The SEC has been studying the problem forever and still can't quite seem to figure out how to stop the practice.

In the fall of 2008, the short sale of 19 financial stocks, iirc, was banned and the rest is history.  Without those legitimate shorts in place to help set a floor later on, we had a doozy of a rout in the markets without finding that firm bottom that short covering rallies always seem to provide.  So we wallowed about for far too long and I think that removing shorts from the game is a mistake.  It may feel good now, but you'll regret their absence later on if the market tanks. 

So the question is, are they planning to ban short selling, or naked short selling?  The former is a huge action with potentially dire downstream implications while the latter is already illegal but still persisting to some degree and it is uncertain how much impact tightening up existing rules will have on the markets.  My guess would be "not much."

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Re: Germany To Ban Short Selling At Midnight

In order to understand why this is dangerous and disruptive to the markets, to ban short-selling, it is necessary to understand that there are two kinds of short selling:  naked and covered.

In a covered short sale, an owner of a stock purchases the right, but not the obligation, to sell that stock at a predetermined price (called the strike price).  The cost of the option is called the premium.  This option provides a mechanism for the stock owner to lock-in a sale price.  Why not just sell it?  The stock owner may anticipate further appreciation, but wants to guarantee a lock-in price in case he is wrong.  Or, the owner could want to stay in the stock for more time in order to qualify for dividends.  It does not really matter why - the point is that covered short selling provides insurance - it guarantees a sale price, and thus provides stability to the marketplace.  Without them, there would be more selling, since stock owners could no longer guarantee a predetermined sale price.  The fact they are willing to pay a premium in order to guarantee the sale price, proves that the risk of not having the options available is real and quantifiable.  Remove the ability to buy sell options, and stock owners will experience increased risk.  This doesn't mean they will all sell, but it certainly means some will.  The net net of it is that this removes a stability function of the marketplace.

In a naked short sale, someone purchases the right to sell a stock that they do not own.  The market made by actual stock owners who do own the stocks they purchase options in, is also available to anyone who wishes to participate.  Naked short sellers are simply speculating on the options market itself, which was intended to be an insurance-like mechanism for actual stock holders, even though they do not own any of the corresponding stocks they buy options in.  Naked short sellers provide liquidity to the marketplace, but they also could (and some say have) distort marketplaces by taking huge positions.

Regardless of what one's opinion is on naked short selling, there is no denying that covered short selling provides stability to the marketplace and is a legitimate market tool.  Whether Germany is banning naked short selling or all short selling I do not know.  Even a ban on naked short selling could be destabilizing as it will remove a lot of liquidity from the marketplace.  High liquidity reduced ask/bid spreads, which is to the benefit of all participants.  Low liquidity forces market makers to take on large ask/bid spreads, increasing premiums for all short sellers- be they naked or covered.

I'm sure there is much more to all this that others on this site are much more versed on than myself, burt that's the best I can muster.

FB

 

Please disregard both of my entire posts and see Dogs' and Rickets' answers.  This is area is obviously not my strong suit, and is definitely theirs. 

 

 

 

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Re: Germany To Ban Short Selling At Midnight
rickets wrote:

Dogs in a Pile:  Good post, however I have to disagree with you regarding short selling putting downward pressure on a stock.  While the process of any sell will put downward pressure on a stock, this short will be covered at some point putting upward pressure on the stock.  The added component is liquidity.

As I alluded to above, when this liquidity from the ability is to short is gone (when the US banned shorts in financials in 08), stocks can suffer more dramatic swings as that liquidity disappears.  Remember, most professional traders and hedge funds short before a stock moves down substantially, and provide liquidity by covering their shorts if the stocks are in freefall.  Net net the buy vs selling pressure created, over time, is zero.

My entire post is only a discussion on shorts with stock in inventory to cover it...not naked.  Naked is a scam....a fraud.

Understood - we are probably debating details in the margins.  It's a fine line - I understand covering the short lifts the price eventually, but selling short puts that initial downward pressure on the stock price and if you sell sufficient inventory short and close the position quickly pocketing the difference that's where it gets a little squirelly for me.

Now if the rules were to change requiring a short seller to hold the position through the clearing period of 3 days or longer, then I would agree that it all comes out in the wash.

Good discussion.......

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Mish's angle

Shock & Awe Phase II: Germany to Ban Naked Short-Selling at Midnight; Politicians Battle Markets; Short Selling Restrictions and Market Crashes

Shock and Awe I worked so "well" that it's time for round II: Germany to Ban Naked Short-Selling at Midnight

Germany will temporarily ban naked short selling and naked credit-default swaps of euro-area government bonds at midnight after politicians blamed the practice for exacerbating the European debt crisis.

The ban will also apply to naked short selling in shares of 10 banks and insurers that will last until March 31, 2011, German financial regulator BaFin said today in an e-mailed statement. The step was needed because of “exceptional volatility” in euro-area bonds, the regulator said.

“You cannot imagine what broke lose here after BaFin’s announcement,” Johan Kindermann, a capital markets lawyer at Simmons & Simmons in Frankfurt, said in an interview. “This will lead to an uproar in the markets tomorrow. Short-sellers will now, even tonight, try to close their positions at markets where they can still do so -- if they find any possibilities left at all now.”

Allianz SE, Deutsche Bank AG, Commerzbank AG, Deutsche Boerse AG, Deutsche Postbank AG, Muenchener Rueckversicherungs AG, Hannover Rueckversicherungs AG, Generali Deutschland Holding AG, MLP AG and Aareal Bank AG are covered by the short-selling ban.

“Massive” short-selling was leading to excessive price movements which “could endanger the stability of the entire financial system,” BaFin said in the statement.

“In some ways, it’s a battle of the politicians against the markets” and “I’m determined to win,” Merkel said May 6. “The speculators are our adversaries.”

Politicians Battle Markets

We have seen this play before. It's hopeless.

Politicians cannot battle markets and expect to win. Wage price controls do not work. The Bazooka ploy failed a dozen times, and the ban on short selling financials in the US failed miserably.

Moreover the Alice's Restaurant Theory of Central Bank Currency Moves is rapidly falling apart.

Short Selling Restrictions - A Great Indicator of Market Crashes

Please consider my January 27, 2010 post Short Selling Restrictions "A Great Indicator of Imminent Market Crashes" Here is the key chart.

Fannie Mae Weekly

click on chart for sharper image

All these short sale restrictions are going to do is create a vacuum. Once the shorts are driven out these shares will plunge.

If history is any guide, there will be a brief rally in German banks, followed by a collapse of unknown duration. Politicians are not bigger than the markets, no one is.

However, politicians can and do frequently exaggerate the existing trend. In this case, the trend is down. Short sellers are not the problem, if anything, short sellers are the cure, exposing problems and failed policies that politicians refuse to address.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Re: Germany To Ban Short Selling At Midnight

Dogs,

How does using a Put not put the same downward pressure on a stock that shorting it does? Is the put option not a derivative of the stock share?

I don't follow your reasoning here?

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Re: Germany To Ban Short Selling At Midnight
cmartenson wrote:

In the fall of 2008, the short sale of 19 financial stocks, iirc, was banned and the rest is history.  Without those legitimate shorts in place to help set a floor later on, we had a doozy of a rout in the markets without finding that firm bottom that short covering rallies always seem to provide.  So we wallowed about for far too long and I think that removing shorts from the game is a mistake.  It may feel good now, but you'll regret their absence later on if the market tanks. 

So the question is, are they planning to ban short selling, or naked short selling?  The former is a huge action with potentially dire downstream implications while the latter is already illegal but still persisting to some degree and it is uncertain how much impact tightening up existing rules will have on the markets.  My guess would be "not much."

Chris -

The ban was temporary.

Link to full article follows.

"The Securities and Exchange Commission on Friday put a temporary ban on short sales of financial firms, in an effort to put a halt to the free-fall of banking stocks. The S.E.C. said the ban, which is effective immediately, would apply to the securities of 799 financial companies.

The S.E.C. said it was acting in concert with its British counterpart, which on Thursday announced new rules to bar short selling.

Calling the ban “a time-out to aggressive short selling”, the S.E.C. said it took the actions to “o protect the integrity and quality of the securities market and strengthen investor confidence.”

“The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets,” the S.E.C.’s chairman, Christopher Cox, said in a statement.

Mr. Cox, pictured above, stressed that the ban was temporary, saying that it “would not be necessary in a well-functioning market”.

http://dealbook.blogs.nytimes.com/2008/09/19/us-and-britain-move-to-ban-short-sales-of-financial-firms/

Greece however recently implemented some fairly draconian measures.

http://gmi.rbcdexia.com/rt/gss.nsf/News+Flashes+by+Date+Mini/694C77897C949F2F85257721004D4231?opendocument

I think if the SEC implemented a requirement to hold short sell positions through the 3 day clearing period, the naked shorts would flush out as "Failure to Delivers".  Rewrite the rules to go back and punish houses that have FTD trades and I think the Naked Short Selling issue goes away.  As you pointed out legitimate short sells are need to establish price floors and such trades would be largely unaffected by any hold period requirement.

The loophole here is the guy who sells naked shorts, sees that the trade is going his way, then goes out and secures sufficient share inventory to "legitimize" the trade.  If the trade is going against him, he closes the position within the 3 day period with a relatively small loss and it never shows up. 

Unless I'm missing something, implementing a hold requirement with punitive measures for FTD trades (as a result of naked shorts) would make it almost impossible for a naked short seller to survive.  Of course such regulatory measures would only work if the knotheads at the SEC were actually providing oversight instead of downloading porn.

 

Dogs_In_A_Pile's picture
Dogs_In_A_Pile
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Re: Germany To Ban Short Selling At Midnight
JAG wrote:

Dogs,

How does using a Put not put the same downward pressure on a stock that shorting it does? Is the put option not a derivative of the stock share?

I don't follow your reasoning here?

The price of a put or call option is derived from the stock price, not the other way around.  Another dynamic is that options have expiration dates and even if an option is 5 strike prices in the money, if it's not exercised it will expire worthless.

Buying and selling options doesn't create a buyer/seller mismatch in the price of the underlying stock.  Because of the time value element of options, two different people could sell options - one call and one put - on the same day and both be profitable, depending on when they originally purchased the option. 

 

For example - lets say I bought June $25 calls on stock XYZ on 3 May when XYZ was trading at $26.  I paid $4 per contract - $1 in real value and for argument's sake,  $3 in time value.  Let's say the stock runs up to $35 - my calls are now worth ~$12 (assume $2 loss in time value).

Now the other side - some other trader has 100 shares of XYZ stock that he paid $45 for.  Some time ago, he purchased a June $45 put -meaning on June 18, he can sell  his XYZ stock for $45/share.  Or he can sell the option for at least $10 in real value plus any remaining time value.

We both sell our options on June 4th for about a $10 profit.  The values of both options were determined solely by the price movement of the underlying stock.  Purchasing the options didn't translate into the stock price - instead, the purchase price of the options were determined by the stock price at the time of purchase (plus time value) and the sale price of each option was determined by the stock price at the time of the sale of the option (plus any remaining time value).

 

The market maker will sometimes move the price of a stock up or down going into expiration Friday so that the largest number of Open Interest Puts AND Calls will expire worthless, but you are talking about huge numbers for Open Interest.

Absent other market factors, short selling almost always results in a drop in stock price.

Erik T.'s picture
Erik T.
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Re: Germany To Ban Short Selling At Midnight

Dogs has it right with the terminology. (But thanks for trying FB, we still love you!)

One thing I don't think was mentioned yet is that the potential unintended consequences of banning short selling are way bigger than most regulators are capable of understanding. In addition to a defensive hedge (already explained earlier), you can't have an options market unless the market makers can delta-hedge their positions.

I don't have time right now to launch into a full description of what delta hedging is (Dogs, go for it!). Very briefly, the only way the options market can function efficiently is if market makers (the people selling most of the options) can create an equivalent "equal but opposite" position to an option they write. They do that through a process called delta-neutral hedging, which requires the ability to sell short. No short selling, no more [efficient] options market.

That's but one example. A whole lot of complex transactions are hedged by short sales. Most shorts are not speculative bets on something failing, but are balanced by other positions.

In summary, banning short selling is a panic move by an ignorant government beurocrat who doesn't understand the full implications of their actions. This sort of regulatory incompetence is exactly what can throw markets into total chaos.

Erik

 

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Erik T.
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Re: Germany To Ban Short Selling At Midnight

Dogs my friend,

I really enjoy your posts and think you're a smart guy. That said, you are very, very confused about the effects of short selling and the ethics of putting downside pressure on prices. It's really not a "fine line" as you said earlier. I think it's a matter of you not fully understanding the big picture.

If you really want to live up to this misplaced notion of "not putting downward pressure on prices for ethical reasons" of yours, then you need to commit to holding all your longs forever and never selling! Exiting a long position (with no subsequent covering event implied) is what puts downward pressure on a stock. Shorting it doesn't (in the long run) for the reasons rickets already described.

You also need to understand that when you use options, you are causing the market makers to go short to delta hedge the options they're selling you. So you've indirectly caused the same outcome. Why would it matter whether you short a stock or cause someone else to do so?

But perhaps more to the point, I respecfully suggest that your whole premise about the ethics of putting downward pressure on a stock is ill-conceived. Asset bubbles form when irrational exuberence is not met and offset by rational economic actors. Any time a fad of any kind gets going, ignorant retails will buy the stock without doing any analysis whatsoever on the fundamentals. Short sellers observe the irrational mal-investments and counter them with shorts, keeping the price somewhat in line with fair economic value. So I could just as easily argue that you are screwing up the market by not doing your duty to short an overpriced stock to help the free market avoid dangerous asset bubbles! That's a slight exaggeration, perhaps, but hopefully you see my point.

I think you need to take a step back, and ask yourself the question "Why have I been assuming that putting downward pressure on a stock is a matter of ethics in the first place?" I don't think you'll find any legitimate answers. It's certainly unethical to try to beat the price of a stock down artificially, as aggressive short sellers like the legendary Jesse Livermore were famous for doing. But shorting a stock because it's a logical economic conclusion that the stock was over-valued is not only ethical, but is necessary (that someone in the marketplace do it) in order to ensure efficient price discovery.

Best,

Erik

 

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Re: Germany To Ban Short Selling At Midnight
Erik T. wrote:

 In summary, banning short selling is a panic move by an ignorant government beurocrat who doesn't understand the full implications of their actions. This sort of regulatory incompetence is exactly what can throw markets into total chaos. Erik 

I make no claim to being a great financial mind, my strengths lie elsewhere, but I do enjoy reading post like this where heavy hitters like yourselves debate high finance.  Absent from this debate is why Germany would make this move.  What is the reason, the motive?  Germany being either the fourth or fifth largest economy in the World I find it hard to believe that a decision of this scope was left to a "ignorant  government bureaucrat", but maybe.  From the information that I was able to gather and understand it is my impression that Germany was left holding much of the financial burden for the recent Greek bailout and is attempting to eliminate the financial mechanism that was largely responsible for wrecking this havoc.  ?

 

Erik T.'s picture
Erik T.
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Re: Germany To Ban Short Selling At Midnight

The more I see floating around the net, the less this makes sense. I'm starting to question whether errant reporting is playing a big part in the confusion. Two points in particular:

  • "Naked" short selling is what's reportedly being banned
  • CDS on European sovereign debt to be "banned"

These things just don't make sense. First, "Naked short selling" is already illegal in the USA although it happens alot, and there's no reason I can think of that these circumstances would warrant specific focus on naked shorts. This tells me either (1) the regulators are completely and totally clueless and don't even know what they are talking about, or (more likely) (2) the reporting on the Internet is misquoting what is actually being proposed. If anyone has a link to an article quoting German officials verbatim - or a press release from the German gov't, please post it here. I think we are probably getting a lot of misinterpreted noise in the system (Is GATA involved?)

Second, banning CDS on sovereign debt is just an absurd statement. The German government has no power or authority to do that. Banning short selling of german gov't bonds is something they might plausibly have jurisdiction to regulate. But most CDS speculators are not on the ground in Germany. If someone in New York enters a contract with someone else in New York that is indexed to a German bund, the German government has ZERO authority to regulate or "ban" that transaction. Their sovereign securities aren't even directly involved.

I'm looking for better data, but until I find it my initial conclusion is that either this is political grandstanding (German officials announcing they are banning something they have no authority to ban might appease their citizens), or else the information we're receiving is bogus. It just doesn't add up otherwise.

Best,

Erik

 

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xraymike79
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Re: Germany To Ban Short Selling At Midnight
Nacci wrote:
Erik T. wrote:

 In summary, banning short selling is a panic move by an ignorant government beurocrat who doesn't understand the full implications of their actions. This sort of regulatory incompetence is exactly what can throw markets into total chaos. Erik 

I make no claim to being a great financial mind, my strengths lie elsewhere, but I do enjoy reading post like this where heavy hitters like yourselves debate high finance.  Absent from this debate is why Germany would make this move.  What is the reason, the motive?  Germany being either the fourth or fifth largest economy in the World I find it hard to believe that a decision of this scope was left to a "ignorant  government bureaucrat", but maybe.  From the information that I was able to gather and understand it is my impression that Germany was left holding much of the financial burden for the recent Greek bailout and is attempting to eliminate the financial mechanism that was largely responsible for wrecking this havoc.  ?

Nacci, I'm in the same camp as you. The reason:

.....

BaFin cited the "extraordinary volatility" afflicting eurozone countries' debt certificates and the widening of spreads on credit default swaps for several nations.

"Against this background, massive short-selling of the affected debt certificates and the conclusion of naked CDS on loan default risks of eurozone states would have as a consequence further excessive price movements," BaFin said in a statement.

Those could lead to "significant detriment for the financial market and could endanger the stability of the whole financial system," it added. It said the ban would be reviewed continuously.

...

European leaders have complained that speculators used credit default swaps on Greek government debt to bet the country would default on its borrowings — raising pressure to the point where it was forced to ask for a bailout.

Finance Minister Wolfgang Schaeuble said Germany was acting in anticipation of European regulations expected to be proposed next month.

He pointed to the "great worries" caused by speculation on debt over recent months as the reason for banning short-selling, and added on ZDF television: "We can do that, and when you do something like this, you don't take a long run-up."

"The German ban seems to be a bit of 'flailing,'" Marc Chandler, the chief foreign exchange strategist at Brown Brothers Harriman, a New York investment firm, said in a market commentary.

He added that "it appears to be half-baked and not really thought out, and plays into market doubts about European policymaking credibility.

...

Chester Spatt, who was chief economist at the U.S. Securities and Exchange Commission from 2004 to 2007, said that Germany's short-selling ban would probably end up causing more market turbulence and not less.

"Like many types of well-intentioned regulation, this is likely to misfire," he said in an interview. "During our financial crisis in 2008, there was a ban on short-sales for about three weeks .... That ban was very counterproductive. It didn't help stabilize asset prices at all."

http://www.canadianbusiness.com/markets/headline_news/article.jsp?conten...

 

Erik T.'s picture
Erik T.
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Re: Germany To Ban Short Selling At Midnight

Ok, a little more context... ZH had some reasonable (for them) reporting on this, but their server seems to have bitten the dust again so I only got a brief taste.

What's actually banned (so far as I can tell) by the Germans:

Naked CDS Positions, meaning you can buy CDS to insure bonds you actually own, but you can't buy CDS as raw speculation against bonds you don't really have. I haven't seen any reporting yet on the obvious question of how Germany proposes to ban contracts that exist primarily outside its jurisdiction.

Short-Selling of Specific Financial Stocks Not all stocks, just a specific list. And this is normal short selling, not naked short selling.

The German officials are demonstrating ignorance of economics so extreme that they just might qualify for a Nobel prize like Paul Krugman! :-) The effects of these moves will be enormous and approximately opposite what they intended. Sheer incompetence, but not terribly surprising.

Erik

 

strabes's picture
strabes
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Re: Germany To Ban Short Selling At Midnight
erik wrote:

The German government has no power or authority to do that. Banning short selling of german gov't bonds is something they might plausibly have jurisdiction to regulate. But most CDS speculators are not on the ground in Germany.

A perfect example of why we shouldn't have debt-based monetary systems...governments lose their sovereignty.  The bond market, and leveraged plays on the bond market like CDS, give predators outside the country the power to eventually takeover the government.  How?

Stage 1:  Because of debt-based money, governments are obligated to steadily increase debt over time (the 1st E of exponential growth) during a long inflationary boom as the sell-side banking institutions (Goldman, JPM, etc) and eminent economists and central banks tell them "you must do this to avoid recessions...it's a good thing."   (the entire economics profession was rewritten to endorse this, so blaming politicians is ridiculous)

Stage 2:  Then for doing stage 1, they get attacked by the other half of the financial system, the buy-side funds (Soros, etc), which collapses their system while everybody again rants about the politicians. (it's neither the politicians, nor the speculators...it's the system)

In both phases the financial class gets rich while sovereign governments are conquered and their populations are put under austerity and have their resources stolen.

The only solution now that stage 1 is over for the US is issuing sovereign money to facilitate a transition phase and wait until the next long credit expansion phase kicks off.  Without that, stage 2 is guaranteed which keeps the financiers in power and will bring us under the IMF SDR to "save" us from those damn politicians (who were basically bulldozed and had nothing to do with it in the first place)

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xraymike79
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Re: Germany To Ban Short Selling At Midnight

 

Strabes,

     The only way to change "the system" is to replace those supporting "the system." Here's one guy trying to do that:

 

 

compinthegroove's picture
compinthegroove
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Re: Germany To Ban Short Selling At Midnight

Ok, a little more context... ZH had some reasonable (for them) reporting on this, but their server seems to have bitten the dust again so I only got a brief taste.

[/quote

I know this is off topic, but what are your preferred sources for financial reporting?

britinbe's picture
britinbe
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Posts: 381
Re: Germany To Ban Short Selling At Midnight

I can imagine the picture

Obama:  Sure Angela, my administration is for greater regulation, we support your actions

Merkel:  Its good to know you are behind us and have similar ideas, we'll talk soon!

Obama: Sure, speak soon.

Phone clicks

Obama: Hey Timmy, you can sell those Tresurey bonds now!

Laughing

Erik T.'s picture
Erik T.
Status: Diamond Member (Offline)
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Posts: 1234
Re: Germany To Ban Short Selling At Midnight

I sure don't get it...

I've been all over the net and everybody (but everybody) is reporting a direct quote of the ban applying to "naked short selling of shares in 10 german financial companies", while nobody (but nobody) is recognizing the plainly obvious issue that this statement makes no sense if "naked short selling" is already illegal for all stocks.

I'm utterly shocked that the media is missing this discrepancy. Either I am missing the point or the entire financial media is missing the point. At risk of sounding arrogant, I think it's them.

My best guess is that the German official was using the term "naked short selling" incorrectly, and the media are just quoting his statement verbatim without bothering to address the fact that on the surface, the words make no sense. I am pretty sure they intend to ban all short selling of those issues, since the other interpretation wouldn't make sense. All I can fathom is that the German official meant to say "naked CDS positions" and "short selling", but he confused his words and nobody noticed. The pattern incompetence of the financial press never ceases to amaze me.

Best,

Erik

 

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