This complaint had to do with REG SHO stocks that were about to be bought in. A MM would trade an ITM call vs stock with another MM with no position, knowing the other party would exercise the long call to not be short stock the next day. The trader buying the stock and selling the call, would claim they covered their short at at the end of that day, and was no longer short the security. This would reset the clock on the failure to deliver which would begin again at T+3. This was not common as was stopped by the SEC with fines for the few that did it. They were "gaming" the reg sho rules. The market maker exception is meant to add depth and liquidity in in the option markets at a time when it's most needed.
I stand corrected, you were right Bob. I thought that MM's still had to get a locate, but apparently not. Though as you said, they still have buy in risk (though I am told it is T+6 instead of T+3). Buy in risk could be substantial though, as you could be bought in on the cash market. Thanks for the information.
Yes, but it is still stupid. - The stock is falling. - I want to short it, but can't. - So, I buy a put. - The MM is now short the put, and likely delta hedged with naked short stock. The stock still gets sold short naked, it's just via the MM.
Correct. Without it, markets would not function properly. One of the responsibilities of regulators is to make sure the markets function as smoothly as possible. The SEC, FINRA and the Exchanges believe that the more depth and liquidity, the better the markets function. So because of that, a regulated industry participate gets a benefit customers don't get. I don't feel it stupid, but can see why you do.
the uptick rule was removed in 2007, there's ongoing debate to re-introduce it but i doubt it will be as statistics showed the rule was useless. some politicians still want to put their name on all kinds of regulations....