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#1 14-06-2021 15:04:41

johnedward
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From: Paris - France
Registered: 21-12-2009
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Short-selling myths: distinguishing fiction from reality

Short-selling myths: distinguishing fiction from reality


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From time to time, short selling is at the center of financial media concerns, whether it is because some people are making money during a bad market downturn, or because management teams are complaining about short sellers (e.g. Tesla / Elon Musk) or because stocks like Gamestop and AMC are the subject of speculative manias.

There are many widely held misconceptions about short selling and myths/conspiracies that have come to light during the Gamestop and AMC stock sagas.

We will briefly examine them below:

Myth #1: It is illegal to short sell more than 100% of the float.

This is not the case. A single share can be loaned multiple times. Each share sold short creates an offsetting long share in the free float (for each seller, there is a buyer).

For example, let's say a company has 100 shares outstanding. Individual A has 90 shares, B has 10.

A lends his 90 shares to C, who then sells them short to D (that is, D buys). A owns 90 shares, B owns 10, and D owns 90.

Adding up all these shares (90 + 10 + 90), 190 shares appear in terms of total ownership and 100 shares are outstanding. In other words, the free float increases and the number of outstanding shares remains the same.

This balances out because there are 90 shares on loan - that is, C owes A 90 shares at some point in the future. It is no different from a loan - debt is a "short term" position. It must eventually be repaid, usually with interest, just as in the case of a stock loan.

The nominal short position is expressed as 90/100 (90%), although in reality it is more like 47%, as this is 90 of the 190 stocks in the free float.

D can lend 90 shares to E. E sells them short to F.

Now we have A who owns 90, B 10, D 90, and F 90, for a free float of 280. The short participation is 180 out of 100 outstanding shares, or ostensibly 180%. But it's actually 64% (180 divided by 280).

In other words, stocks can simply be re-borrowed over and over again. F can lend to G, and so on.

There is nothing illegal or immoral when the Nominal Open Float is greater than 100%.

Myth #2: naked short selling is unethical and/or illegal.

Naked short selling occurs when a person who is short on a stock fails to fulfill their obligation to the buyer. It is illegal to do this intentionally, but it rarely happens.

In the event of a failure to deliver, the broker will tell him to remedy the situation. There is a lot of legal risk for no gain.

Myth #3: This was David vs. Goliath, Main Street vs. Wall Street.

No, it was originally powered by social media. It went viral and overtook Reddit and other social media to reach the mainstream press. There have been a few short hedges by hedge funds, but only a few.

Hedge funds do not represent a large part of the asset management industry, only around $3 trillion. The asset management industry is worth close to $45 trillion in the United States alone.

"Wall Street" - which is generally used as a metonym for the financial industry as a whole - also includes investment banks, brokers, lenders, other asset management companies (for example, mutual funds investment, passive managers) and other types of financial companies.

Many of these companies have made a lot of money by being long on these stocks, selling volatility, making these markets (reducing the spreads between bid and ask), lending, collecting commissions and other similar activities.

Some people were able to lose a lot and gain a lot on either side of the deal and all the strategies in between. But it happens all the time, every day, in all kinds of markets. The "shorts" may have lost in the short term and the "longs" who bought the stocks at high levels, especially with leverage, will also lose a lot.

The story of the little guy versus the big guy is selling well, but it's a myth.

Myth #4: Short selling hurts a business and can lead to bankruptcy.

Businesses go bankrupt because they cannot pay their debts. It is never because short sellers drove the stock price down.

The assets and liabilities of a balance sheet have little to do with the valuation of stocks by public markets on the basis of the market.

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