This financial crisis has destroyed a lot of wealth for many investors. There are many who are blaming it on Short Selling and the abolished Uptick Rule. Uptick Rule was abolished by SEC in June 2007, after being in place since 1938. Currently, SEC is encouraging a debate, if or not to put Uptick regulations back in place.
What is or rather was Uptick Rule? Uptick Rule prohibited short sale of securities, except on an uptick. Meaning, a short seller could only sell equities at a price higher than the last transaction price (higher at least by the defined uptick amount).
To me, I will take it as a market distortion rule and would support its abolition. Short Sales are important to keep markets healthy by keeping underlying prices close to their true equilibrium values. Without short sales, securities would mostly have an upward bias and be over valued. So, any regulation which discourages short sales as a correction instrument is not healthy for markets as a whole.
Having said that, it is important to understand difference between a ‘Short Sale’ and a ‘Naked Short Sale’.
In a Short Sale, seller borrows security from security owner for a short period and sells it at the market price. He is betting negatively on that company and stock, and is expecting it to be overpriced. At the end of period, seller buys it from the market (at lower prices if his bet has played correctly) and returns it back to its owner. Owner is usually an individual or institution (e.g. pension funds, ETF etc), who anyways wants to keep that security for longer term. Owner receives interest on his lending and borrower (short seller) gets to play on his bet. (If I were the owner, I would also charge premium for impairment risk on my security)
In a ‘Naked Short Sale’, seller is short selling securities without borrowing them. This is a clear distortion of market factors. He is selling something, he does not have (or no one has). His action is artificially increasing supply of that security and if the volume of this artificial supply is critical enough, it will anyways bring down the prices. This is Basic Economics; things have value, because they are scarce.
To summarize, I will take Short Selling as a healthy Correction Tool and ‘Uptick Rule’ and ‘Naked Short Selling’ as two factors distorting its correction properties. ‘Uptick Rule’ by discouraging short selling and ‘Naked Short Sales’ by abusing it.
What is or rather was Uptick Rule? Uptick Rule prohibited short sale of securities, except on an uptick. Meaning, a short seller could only sell equities at a price higher than the last transaction price (higher at least by the defined uptick amount).
To me, I will take it as a market distortion rule and would support its abolition. Short Sales are important to keep markets healthy by keeping underlying prices close to their true equilibrium values. Without short sales, securities would mostly have an upward bias and be over valued. So, any regulation which discourages short sales as a correction instrument is not healthy for markets as a whole.
Having said that, it is important to understand difference between a ‘Short Sale’ and a ‘Naked Short Sale’.
In a Short Sale, seller borrows security from security owner for a short period and sells it at the market price. He is betting negatively on that company and stock, and is expecting it to be overpriced. At the end of period, seller buys it from the market (at lower prices if his bet has played correctly) and returns it back to its owner. Owner is usually an individual or institution (e.g. pension funds, ETF etc), who anyways wants to keep that security for longer term. Owner receives interest on his lending and borrower (short seller) gets to play on his bet. (If I were the owner, I would also charge premium for impairment risk on my security)
In a ‘Naked Short Sale’, seller is short selling securities without borrowing them. This is a clear distortion of market factors. He is selling something, he does not have (or no one has). His action is artificially increasing supply of that security and if the volume of this artificial supply is critical enough, it will anyways bring down the prices. This is Basic Economics; things have value, because they are scarce.
To summarize, I will take Short Selling as a healthy Correction Tool and ‘Uptick Rule’ and ‘Naked Short Selling’ as two factors distorting its correction properties. ‘Uptick Rule’ by discouraging short selling and ‘Naked Short Sales’ by abusing it.
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Nice one!!
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