The stock market is pretend until it isn’t

Sometimes, calls get called. When the stock market becomes real, it becomes very real.

Consider the naked short, explained in this medium post, “GameStop: Power To The Market Players,” by Nope, It’s Lily:

If you’ve been anywhere in the trading universe, it’s been partly a meme and partly a higher calling to long $GME since about July/August 2020, when everyone suddenly realized the short interest on $GME actually exceeded its available float. In English, this meant that there were more shares sold short (a strategy to benefit from the stock price going down, this involves borrowing a share to sell with the intent to repurchase it at a lower cost later) than actually available to buy. How does this happen exactly?

This can happen one of two ways:

Naked shorting — This is a mostly illegal practice in which an individual or institution first sells shares without locating that they well, actually exist. This is fairly sneaky, but works as long as they can find the shares before the settlement period (delivery date) of the shares actually occurs. If they find it before then, no one is the wiser (except the SEC, when it decides to do anything ever).

Despite what idiots online believe, naked shorting isn’t always illegal (hence the word mostly). In particular, the ban on naked short-selling (Regulation SHO) isn’t because the government thinks you’re a meanie for doing it, but because of its hypothesized connections to the 2008 financial crash (actual data on it is mixed). In general, the belief was that naked short sellers helped destabilize investor confidence in the banks, leading to that fun period best remember by watching The Big Short accompanied by a full handle of Svedka.

Naked shorting, however, is legal by bona-fide market makers, which according to our SEC friends means simply it is done to hedge an option position sold (as part of market making duties, to buy and sell a security at publicly stated prices) rather than for speculation. If you want to read boring legal stuff, here’s a link to Regulation SHO.

Similarly, despite what your favorite rocket-emoji’ing internet guru believes, causing an actual short squeeze is hard, and almost always mostly illegal. The last public short interest (the next one should be released on January 27th, per FINRA reporting) on GME was released on Dec 31st, 2020.

Second bold mine.

I can’t say I understand the article. My first experience with this journalist. I’ll be interested to see what happens on January 27th.

The GameStop story is very compelling. Matt Levine’s take as always definitive. Comparisons to what Trump and Trumpians did to the GOP (and then the country) in 2016: an ebullient Internet-centered group of trolls realize there are tricks they can use to mock and demolish the establishment players, moving faster than the other guys can say “hey, what a second, that isn’t how we play!” The end result of that gleeful message board based takeover was (glances at Washington) huh looks like establishment people with 40 plus year careers are back in control of all branches after a brief reign of chaos (though they are rattled by what happened).

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