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A World Without Shorts

by: Felix Salmon September 19, 2008    
Felix Salmon

Felix Salmon

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The SEC has now implemented its short-selling ban: it's on 799 financial stocks, which, interestingly, do not include XLF, the biggest ETF for financial stocks. In theory, if you wanted to short a given stock in the XLF basket, you could short XLF and then just buy the individual components you weren't interested in. But there are easier ways of shorting, like selling calls or buying puts.

With short-selling banned, there will probably be a substantial move into the options market by the erstwhile shorters. That might well drive down the price of call options, especially on financial stocks but also on broader indices. And I'm reminded of the advice that call options can be a smart investment anyway, especially for younger investors who can afford to lose their money. If that was something you were thinking about already, right now (or some point over the next few weeks) might be a great time to enter the position.

On the other hand, all options get significantly more expensive in times of high volatility, so maybe the effect of the short-selling ban will simply be to make call options slightly less expensive than they were, but far from cheap.

I do wonder though about the opportunities this financial crisis provides to investors who can stomach illiquidity and have a long time horizon. There are many such investors out there, both retail and financial, not to mention all those university endowments, sovereign wealth funds, and the like. Does anybody have an idea of where the long-term, locked-up money is going?

As for anybody thinking of trying the short-XLF play, I have some simple advice: don't do it. It's more stupid than clever, and if anybody catches you trying to make such an obvious end-run around the new regulation, you'll deserve the large fines the SEC will surely find some way to impose on you. After all, anybody doing such a thing is a financial terrorist!

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This article has 17 comments:

  •  
    Sep 19 09:39 AM
    So here's the deal. I lost my job at a financial firm, lost all or most of the value in my ESPP, and the 401k match. So I figure, I lost so much money due to the financial industry, I might as well short it. If you can't beat 'em, join 'em. Now I am losing again. I love government intervention.
    Reply
  •  
    Sep 19 09:48 AM
    I would say that "financial terrorist" is a bit too strong to describe short sellers. It's a bit of a conspiracy theory to believe that multi-billion dollar financial companies, held by some of the most sophisticated funds in the world, can be pump-and-dumped like some $2m market cap penny stock. These companies have lost value because they made leveraged bets on no-income, no-job, no-assets half-million dollar mortgages. That's why nobody wants their stock.

    What next, will we call forex traders the "currency insurgents" driving down the value of the dollar (and the fundamentals have nothing to do with it?)?

    Should we call people driving energy efficient cars "energy saboteurs" and blame them for the losses of oil investors over the last 3 mos?

    Will we ban the longs from selling their stock to prevent the stock from going down?

    And since when was it the government's job to prevent investors' assets from declining in value? Isn't that what it tried to do with housing a few years back? Will the govt. go back and restore the stock value of pets.com, at the expense of the taxpayer and the dollar?
    Taxpayers are passive enough, why not?
    Reply
  •  
    Sep 19 09:57 AM
    There is a lot of denial on the part of the shorts. If they don't cover, they are really going to regret it!
    Reply
  •  
    Sep 19 10:30 AM
    There is some misperception by investors on the SEC short sale rule. It only pertains to NEW Short sales - existing positions don't have to be covered.
    Reply
  •  
    Sep 19 11:00 AM
    Banning short sales will widen the bid/ask spread in options.

    When you buy a put, the market maker offsets his position by shorting the stock until he can buy the put back from someone else at the other side of the bid/ask spread (then he buys back the short position). That way the market maker can greatly reduce the risk while he waits to collect the difference in the bid/ask spread. Gains/losses in the puts will be offset by losses/gains in the short position.

    Take away his ability to short the underlying and he has to gamble that the underlying price won't move very far before he offsets the put position. Since there will be some movement, the spread will widen to counter the risk of loss due to the inability to offset by shorting.

    Liquidity in the financial put options will be reduced as no market maker will want to take immense gambles on directional positions without being able to use offsetting shorts.
    Reply
  •  
    Sep 19 11:01 AM
    Let me tell you something. This is all a ruse. Theres not enough paper in all the forests of the world to buy all this cr@p! This is end game folks. I wonder what the Chinese are thinking, after the hangover of the initial euphoria. Maybe they forget they hold 2T$ that are being debased as we speak and the fireworks are going off.

    Tip to foriegn central bankers: If you don't recognize the sucker at the table, chances are its you.
    Reply
  •  
    Sep 19 11:22 AM
    one indeed can play the options market but it is a lost battle to bet against a market that the government has ordered to go only up.
    Reply
  •  
    Sep 19 11:39 AM
    I am completely befuddled. What should I do with SKF now?
    Reply
  •  
    Sep 19 12:25 PM
    Smarty_Pants...the order exempted market makers:

    "The following entities are excepted from the requirements of the Order: registered market makers, block positioners, or other market makers obligated to quote in the over-the-counter market."
    Reply
  •  
    Sep 19 02:37 PM
    Ban on short sales = time window for wall street insiders to bail out.
    Reply
  •  
    Sep 19 04:59 PM
    I assume your "Financial Terrorists" comment was sarcastic. Clearly the financial terrorists are the Wall Street banks who looted the system for trillions of dollars.
    A question: why would anyone pay their credit card bills if the Govt. forces taxpayers to absorb trillions in losses from banks off balance sheet worthless holdings? And why wouldn't the bankers and politicians not be jailed who exempted banks from off-balance sheet rules after the Enron "lesson".
    Reply
  •  
    Sep 19 10:15 PM
    Naked shorters NEVER need to SHORT. They just leave the shares in the systems and change the name of the firm with a new PO box on the Cayman Islands. This is just like writing bad check except they have the police in their pockets. Supply and demand. The more fake shares you print the more you can destroy a stock. This is NOT about a balance market it is about Corruption of our market our congress and our government. This is terrorism of our way of life. These guys are like ever increasing parasite that will weaken and destroy our country. We need the military and Guantanamo bay and water boarding and trial and execution for the threats against this country.

    This is no longer a small issue these guys are destroying our financial systems and our economy.
    Reply
  •  
    Sep 20 01:04 PM
    My prediction: No matter what the government does, it can't make bankrupt companies solvent. The dollar is going to sink sharply, gold will soar. Where does our government which is already O/D to the max keep coming up with hundreds of billions more for bailouts??? I guess the printing presses are working overtime??
    Reply
  •  
    Sep 20 06:18 PM
    Yes, I'm a Socialist, but the shorts were beginning to actually destroy this country. When they went after Lehman and Bear Sterns , fine, whatever. But then they began to target GS and MS , perfectly fine companies, like sharks in a feeding frenzy. I found it interesting to find out what the true value of these companies was on Fri when the shorts got put in their place.
    Reply
  •  
    Sep 20 09:15 PM
    jcollins01

    Please don't misunderstand Friday's price action. Goldman is in big trouble because their longs dumping them (the short interest on GS is small). The prices mysteriously popped (read that manipulated) overnight and in Goldman's case, still drifted lower all day. That can only be longs liquidating.

    There is no such thing as a "perfectly fine" investment bank right now. The world's financial system damn near collapsed last week, and it had nothing to do with the shorts.

    I kid you not when I say this may be the smartest time to panic.
    Reply
  •  
    Sep 21 02:47 AM
    The government did the right thing this time.
    Millions of people sleep better so stop complaining.
    If the government did nothing, most hospitals probably filled with patients already. Stress, you know.
    Reply
  •  
    Sep 22 12:41 AM
    regardless how good Goldman are, they need suckers to rip off. with 3 of their competitors already gone and another probably very soon, there is not enough money on the table for them to maintain the profits from yesteryear, most of which were coming from trading and not investment banking.
    Reply
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