In a poker game, if after 30 minutes you don’t know who the sucker is, then it’s probably you. What started this line of thinking is Bridgepoint Education, Inc. (BPI) and their high short sale interest.
Naked selling is the illegal practice of short selling shares that you do not own. Ordinarily, traders must borrow a stock, or determine that it can be borrowed, before they sell it short. But due to various loopholes in the rules and discrepancies between paper and electronic trading systems, naked shorting continues to happen.
While no exact system of measurement exists, most point to the level of trades that fail to deliver from the seller to the buyer within the mandatory three-day stock settlement period as evidence of naked shorting. Naked shorts may represent a major portion of these failed trades.
From www.deepcapture.com:
- But while the SEC is of no help, most any Wall Street broker can describe several “proprietary” strategies that are popular with unscrupulous hedge funds. One such strategy is known as a “married put.” Normally, a hedge fund buys from a market maker a certain number of put options—the right to sell a stock at a specified price at a specified date. If on that date the stock has lost value to the point it is below that specified price, the buyer of the put option (the hedge fund) makes money, and the seller (the market maker) loses money. To hedge the risk that he might lose money, the market maker, at the same moment that he sells the put option, also short sells the stock. This is perfectly legal. But some market markers conspire with hedge funds to drive the stock price down. Instead of merely shorting the shares into the market, the market maker naked short sells the shares, and, importantly, sells those phantom shares to the same hedge fund that bought the puts. As a result, the hedge fund manager winds up with the puts and a matching number of shares (actually phantom shares that are never delivered to him, but about which he never complains, or forces delivery, as that would create upward pressure on the stock, the precise opposite of what he wants). Because the puts and the phantom shares are equal in number and arrive together at the hedge fund, they are known as “married puts”. Once in possession of the phantom shares, the hedge fund manager proceeds to fire them into the marketplace. But he is able to say that he never naked shorted because all he has done is sold the shares that he bought (wink wink) from the market maker. Either way, the effect is to flood the marketplace with phantom stock. The hedge fund makes money. And the market maker is rewarded with more business selling married puts. In the slang of Wall Street, these married puts are known as “bullets.” Through their maneuverings, the option market maker and hedge fund manager synthesize a naked short position that puts “bullets” into the hands of the hedge fund. The hedge fund fires those “bullets” at the stock to make it collapse, timing the last “bullet” to fire as the hedge fund’s put option expires profitably. If the option position nears expiration and looks like it will expire at a loss (“out of the money”), the hedge fund manager goes back to the option market maker, and together they reload by creating more "bullets"
The www.deepcapture.com article continues:
- Incidentally, the fee charged for such puts do not follow any normal option model pricing (in fact, the exchanges search for married puts by looking for options that are mispriced in relation to Black-Scholes, the standard formula that prices options). That is because their pricing is not really a function of any math or statistics, but is a function of the willingness of the hedge fund to pay the option market maker to help him break the rules against naked short selling. And that willingness is a function of how difficult it is for the hedge fund to use other loopholes to break those rules.
How do I find naked shorts?
There are several good short sale sites.
- www.buyins.net
- http://www.shortsqueeze.com/
- http://www.highshortinterest.com/
Where Can I Find Threshold Lists data?
A “threshold security” is any equity security where, for five consecutive settlement days:
- There are aggregate fails to deliver at a registered clearing agency of 10,000 shares or more per security;
- The level of fails is equal to at least one-half of one percent of the issuer’s total shares outstanding; and
- The security is included on a list published by a self-regulatory organization (SRO).
There is a 13 day grace period before a transaction is put on the threshold list.
Each SRO is responsible for providing the threshold securities list for those securities for which the SRO is the primary market. You can obtain SRO threshold lists at the following websites:- Nasdaq: http://www.nasdaqtrader.com/aspx/regsho.aspx (includes Nasdaq issues, OTCBB, and other OTC issues)
- AMEX: http://www.amex.com/amextrader/tradingData/RegSHO/TrDa_RegSHO.jsp (Amex listed securities only)
Bottom line to BPI?
Since writing this post initially, the short interest on BPI has gone from 56.14% to 81.40% according to Yahoo.finance.com; However, there seems to be no listing of it on the threshold lists.
It appears, even though this is a controversial sector, that there is no naked short manipulation going on. This equity could play out either way, but the market and regulators will decide its fate, not the manipulators.
Related articles:
-This behavior is consistent with the illegal “reset” transaction described in the enforcement case brought by the SEC against naked short seller Steven M. Hazan
-A way around the "uptick rule"
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