Naked short selling vs. Naked buying

Discussion in 'Trading' started by i4i, Oct 17, 2009.

  1. i4i


    Lately, I've been thinking a lot about the opposite of naked short-selling: naked buying. It's easy to point out that you can't sell more than the outstanding shares in circulation. But the same logic doesn't seem to apply when it comes to buying. Suppose that XYZ issued 100,000 shares to the public and I happened to have bought the first 90,000. I am a buy-and-hold investor who plans to hold my position in perpetuity. One day, the stock price soars and the volume swells ten times its average daily volume. [By the end of the day, it's been secretly revealed to me that more than 10,000 share were in circulation.]

    Now, technically speaking, you can't buy anything unless someone is willing to sell, and you can't sell what you don't already have. So the only way you can buy is when somebody essentially engages in "naked short selling". Hence my question. Is it considered illegal to conduct naked short selling when the market is plunging but perfectly legal in a rally?

    Perhaps I got this all screwed up. I don't know. Maybe someone who's more astute in these matters could point me in the right direction.
  2. I never understood all the hooplas surrounding the naked short selling (NSS). For me, the logic behind NSS doesn't make any sense. They say NSS occurs when ya bite off more than you can chew, figuratively speaking. But how could that be even possible?

    Taking i4i's example, assume I bought the remaining 10,000 shares of XYZ. I then turned around and sold the shares to my neighbor Fred. Before the ink even dries, there comes Henry who wants in on the action. He wants to buy 6,000 shares. So I turn around and ask Fred whether I could borrow 6,000 share from him, which I promise I will return with interest. He agrees to my request and I sell (or sell short in this case) the 6,000 I borrowed to Henry. Before long, Steve shows up at the door asking for 10,000 shares of XYZ. I make my rounds to both Fred and Henry, who each holds 4,000 and 6,000 shares, respectively. With their blessings I come away with 10,000 shares that I quickly dump on Steve.

    Now, let's not forget the float or the outstanding shares in circulation, which was 10,000 shares. By my calculation, however, the number of shares outstanding at the end of the day is 26,000 shares (Fred 10,000, Henry 6,000, and Steve 10,000). Tomorrow, it will only get more interesting because I plan to borrow and sell short those 26,000 shares.

    That said, the most hilarious thing is that the same concept can be used, at least in theory, in a bull market no differently than its applied in a bear market. But nobody seems to mind when prices go up. It's only when the market is going down the drains the NSS is deemed evil.