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July 16, 2008
New "Emergency" Short Sale Rules
There is an advantage to having Cox, a politician, as head of the SEC. When a false crisis is in the press he knew to respond with a largely symbolic answer that the press can trumpet as well -- emergency short sale rules and promised to prosecute false rumor purveyors. The NY Times put it on the front page (the acid test for success of a chimera) and even Drudge picked it up. The "new" rules redefine naked short selling, which is largely illegal unless one is a market maker, to include cases in which a borrower of stock and the loaner of stock are casual in identifying the stock so loaned. Now the stock must be identified specifically, making it more difficult for some stock owners to loan stock more than once (there is little data on how serious a problem this is). Big whoop. He also promises to crack down on negative false rumor mongers, a crime equal in theory to positive false rumor mongers. Cox will find one, who has left a smoking gun in his email box, and sacrifice him or her. I am grateful that he is not doing more to regulate short sales or other "speculators" in oil futures and the like. Traders know that one can short a stock by selling futures or call options, buying puts, or taking the short side in swaps. Even the small fry get in. I have been shorting financial by simply buying an ultra short ETF traded on AMEX, call numbers SKF. The point -- short sales of stock are a drop in the short side bucket. The higher transactions costs of a true short sale will cause traders to use the other devices. The illusion of control seems to make an ignorant, alarmist press happy and politicians know how to manipulate it -- as Cox does.
July 16, 2008 | Permalink
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Comments
I largely agree with you. However, if they should extend this rule and you want to short a stock for which no options trade, you're out of luck. Unfortunately, so are the buyers because th specialist will execute their market orders anywhere he wants without competing sellers. This is the case for very small, illiquid, retail driven stocks.
Since the SEC informed the industry of the rule change during his testimony, everyone on the street was caught by surprise. It was not immediately clear if market makers would continue to be exempt from the rule to provide liquidity.
Unfortunately, while a bearish position can be established for stocks on which options trade, prepare to pay more for your puts. If options market makers will be required to locate first (let alone actually borrow the stock), they won't be able to hedge efficiently and the premium for the put will rise significantly to reflect the additional risk. The question we have to ask is what are we getting in return for this additional cost?
Finally, one correction to your assessment of the rule: currently, you are required to locate (identify) the stock before shorting it. The locate desk identifies the number of shares it thinks it can borrow and allows the brokerage client to short, actually borrowing the stock only after it has been shorted. In the case of a hard to borrow stock, the shorting trader usually pays interest instead of collecting it. The interest owed doesn't start to accrue until the stock is shorted. The new rule will require the locate desk to actually borrow the stock BEFORE a trade is executed. This means that a trader will pay interest on hard to borrows even before he actually enters a trade or risk not being able to short at all.
The thing that gets lost in all this hatred of short sellers is that short selling is often a hedge in an overvalued asset against long exposure in an asset deemed undervalued. This actually reduces the volatility in a portfolio and assets more efficiently priced. Removing the ability to bring overvalued assets down to fair value amounts to price controls. But what else are we to expect of government?
Posted by: Methinks | Jul 17, 2008 7:19:06 PM
