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A basic question on shorting


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I do not see shorting a stock causing any fundamental damage to the company. Correct me if I'm wrong.

 

For most companies that is true. It is not true for companies that need to access the capital market frequently, like most financials or even MLP that have financing needs to that access capital markets for debt and equity.

 

Financials in particular need to roll over debt, over gibt credit etc literally every day and and their reputation is extremely important in the view of their stakeholders (counterparts, customers, depositions, creditor). A severely lower share price and undermine confidence na impact the business very quickly. That’s the reflexivity principle. For other companies (industrials, even tech) that is much less the case.

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I do not see shorting a stock causing any fundamental damage to the company. Correct me if I'm wrong.

 

That is relatively true today.  Not so about 15 years ago.  Back then the DTC was not able to guarantee T+3 delivery of shares and you had what was called "naked shorting".  Essentially, you would have large hedge funds take huge short positions against low float stocks, and slowly drive the price down as the time to delivery grew longer and longer.  At its peak for example, you could short Overstock.com and the time to delivery of the actual stock was 4 months plus. 

 

So you were creating artificial shares in the short term that were being shorted and the market price would be driven down in a short period of time.  If the company was even slightly vulnerable, the stock price would become so low that it would be ridiculous to raise capital through an equity issuance and institutions would not even consider a debt issuance. 

 

This was done to Bear Stearns during the financial crisis by a group of hedge funds.  This was also done to Fairfax and if it weren't for $300M being raised through Cundill Funds, South Eastern Management and Markel, Fairfax could have been driven out of business back in 2003. 

 

It took about 7 years for the SEC to fix this issue, and today you have efficient markets delivering on time or institutions face consequences.  So shorting is no longer detrimental, but assists in making the market efficient.  Cheers!

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Shorting is typically not a problem for a company until it is abused, and posters have referenced very good examples.

 

The issue to date has been that for those abusing; they have long had the pretty much exclusive ability to gang up on a target, and slip a few banana peels under it. Now, the abusers can be suffocated via a short squeeze, that can be maintained for longer than the abuser can survive. Hence the abuser with large short losses, that cannot roll their short-term notes as they come due, will collapse almost immediately.

 

All that the abuser can do, is try to take down as many others with it that it can. Contagion.

Problem is that the social media swarm needs heads, and the sooner they get them, the better for everyone else.

 

Interesting times.

 

SD

 

 

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I do not see shorting a stock causing any fundamental damage to the company. Correct me if I'm wrong.

 

For most companies that is true. It is not true for companies that need to access the capital market frequently, like most financials or even MLP that have financing needs to that access capital markets for debt and equity.

 

Financials in particular need to roll over debt, over gibt credit etc literally every day and and their reputation is extremely important in the view of their stakeholders (counterparts, customers, depositions, creditor). A severely lower share price and undermine confidence na impact the business very quickly. That’s the reflexivity principle. For other companies (industrials, even tech) that is much less the case.

 

My understanding is that the scenario you mentioned is the problem with the lower stock price - which maps to the low equity value for the company. But does shorting bring down the price of the stock artificially?  (The news about someone's short position or badmouthing about the company could bring down the company. But does the process of shorting - will it bring down the stocks?)

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But does shorting bring down the price of the stock artificially?

 

It brings down the price of the stock, but not artificially. Someone shorting shares is selling them, effectively adding supply to the market. Just like if you sell long shares, you are effectively adding supply to the market.

 

If you increase supply relative to demand, the price goes down. If you increase demand relative to supply, the price goes up. So you are helping to push the price down, since you're adding supply, but there's nothing artificial about it.

 

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I’m no expert on shorting. But I think that shorting as a general concept doesn’t cause fundamental damage. It could create a lot of opportunities when it’s overdone or not warranted.

 

However, if not regulated properly it definitely can. Just with velocity - it could leave a struggling company with insufficient time to make a turnaround plan or to get access to loans. If the velocity is too high it can also have a reflexive effect.

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